Solution Manual For Advanced Accounting, 3rd Edition(2002 Fasb Update)

CHAPTER 2 Note: The letter A or B indicated for a question, exercise, or problem means that the question, exercise, or problem relates to a chapter appendix. ANSWERS TO QUESTIONS 1. At the acquisition date, the information available (and through the end of the measurement period) is used to estimate the expected total consideration at fair value. If the subsequent stock issue valuation differs from this assessment, the Exposure Draft (SFAS 1204-001) expected to replace FASB Statement No. 141 specifies that equity should not be adjusted. The reason is that the valuation was determined at the date of the exchange, and thus the impact on the firm’s equity was measured at that point based on the best information available then. 2. Pro forma financial statements (sometimes referred to as “as if” statements) are financial statements that are prepared to show the effect of planned or contemplated transactions. 3. For purposes of the goodwill impairment test, all goodwill must be assigned to a reporting unit. Goodwill impairment for each reporting unit should be tested in a two-step process. In the first step, the fair value of a reporting unit is compared to its carrying amount (goodwill included) at the date of the periodic review. The fair value of the unit may be based on quoted market prices, prices of comparable businesses, or a present value or other valuation technique. If the fair value at the review date is less than the carrying amount, then the second step is necessary. In the second step, the carrying value of the goodwill is compared to its implied fair value. (The calculation of the implied fair value of goodwill used in the impairment test is similar to the method illustrated throughout this chapter for valuing the goodwill at the date of the combination.) 4. The expected increase was due to the elimination of goodwill amortization expense. However, the impairment loss under the new rules was potentially larger than a periodic amortization charge, and this is in fact what materialized within the first year after adoption (a large impairment loss). If there was any initial stock price impact from elimination of goodwill amortization, it was only a short-term or momentum effect. Another issue is how the stock market responds to the goodwill impairment charge. Some users claim that this charge is a non-cash charge and should be disregarded by the market. However, others argue that the charge is an admission that the price paid was too high, and might result in a stock price decline (unless the market had already adjusted for this overpayment prior to the actual writedown). 5B. The acquisition method treats a combination as the acquisition of one or more companies by another. The pooling of interests method, in contrast, interprets a business combination as the process of two or more groups of stockholders uniting ownership interest by an exchange of equity securities. This method (pooling) is no longer allowed for acquisitions after June 30, 2001. However, accounts resulting from previous acquisitions that used the pooling method will continue to be carried forward under the valuations implied by that method. Under the acquisition method the identifiable assets acquired and liabilities assumed are recorded at their fair values at the date of acquisition. Any excess of total implied value over the sum of these fair values is recorded as goodwill. Under the pooling method fair values of assets and 2-1 liabilities were ignored, and the assets acquired and liabilities assumed were carried forward to the new or surviving entity at their recorded (book) values. Financial statement differences resulted from the use of one method rather than the other. The purchase method normally results in higher asset values. To the extent that these higher values relate to depreciable assets and inventories, future income charges are greater. (Also, bond discounts, under the purchase method, must be amortized to future periods, and in the past goodwill was amortized under the purchase method.) Thus, the use of the pooling method generally resulted in greater future earnings, lower asset values, and greater returns on assets. 6B. Net income would be the highest under the pooling method (no excess depreciation or goodwill amortization), lowest under the former purchase rules (before FASB Statement No. 141, both excess depreciation and goodwill amortization), and intermediate under the purchase rules after FASB Statement No. 141 (excess depreciation only). Assets would be higher under the purchase method, either old or new rules. In fact, under the new rules, total assets will remain higher than under the old purchase rules because goodwill, once recorded, is not amortized. 2-2 Business Ethics Solutions Business ethics solutions are merely suggestions of points to address. The objective is to raise the students’ awareness of the topics, and to invite discussion. In most cases, there is clear room for disagreement or conflicting viewpoints. The board has responsibility to look into anything that might suggest malfeasance or inappropriate conduct. Such incidents might suggest broader problems with integrity, honesty, and judgment. In other words, can you trust any reports from the CEO? If the CEO is not fired, does this send a message to other employees that ethical lapses are okay? Employees might feel that top executives are treated differently. ANSWERS TO EXERCISES Exercise 2-1 Part A Receivables Inventory Plant and Equipment Land Goodwill ($2,154,000 – $1,824,000) Liabilities Cash 228,000 396,000 540,000 660,000 330,000 Part B Receivables Inventory Plant and Equipment Land Liabilities Cash Gain on Business Combination ($1,230,000 – $990,000) 228,000 396,000 540,000 660,000 594,000 1,560,000 2-3 594,000 990,000 240,000 Exercise 2-2 Cash Receivables Inventories Plant and Equipment (net) ($3,840,000 + $720,000) Goodwill Total Assets $680,000 720,000 2,240,000 4,560,000 120,000 $8,320,000 Liabilities Common Stock, $16 par ($3,440,000 + (.50  $800,000)) Other Contributed Capital ($400,000 + $800,000) Retained Earnings Total Equities 1,520,000 3,840,000 1,200,000 1,760,000 $8,320,000 Entries on Petrello Company’s books would be: Cash Receivables Inventory Plant and Equipment Goodwill * Liabilities Common Stock (25,000  $16) Other Contributed Capital ($48 – $16)  25,000 200,000 240,000 240,000 720,000 120,000 320,000 400,000 800,000 * ($48  25,000) – [($1,480,000 – ($800,000 – $720,000) – $320,000] = $1,200,000 – [$1,480,000 – $80,000 – $320,000] = $1,200,000 – $1,080,000 = $120,000 2-4 Exercise 2-3 Accounts Receivable Inventory Land Buildings and Equipment Goodwill Allowance for Uncollectible Accounts ($231,000 – $198,000) Current Liabilities Bonds Payable Premium on Bonds Payable ($495,000 – $450,000) Preferred Stock (15,000$100) Common Stock (30,000$10) Other Contributed Capital ($25 – $10) 30,000 Cash 231,000 330,000 550,000 1,144,000 848,000 33,000 275,000 450,000 45,000 1,500,000 300,000 450,000 50,000 Cost paid ($1,500,000 + $750,000 + $50,000) = $2,300,000 Fair value of net assets (198,000 + 330,000 + 550,000 + 1,144,000 – 275,000 – 495,000) = 1,452,000 Goodwill = $848,000 Exercise 2-4 Cash Receivables Inventory Land Plant and Equipment Goodwill* Accounts Payable Bonds Payable Premium on Bonds Payable** Cash 96,000 55,200 126,000 198,000 466,800 137,450 44,400 480,000 45,050 510,000 ** Present value of maturity value, 12 periods @ 4%: Present value of interest annuity, 12 periods @ 4%: Total present value Par value Premium on bonds payable 0.6246$480,000 = 9.38507$24,000 = *Cash paid Less: Book value of net assets acquired ($897,600 – $44,400 – $480,000) Excess of cash paid over book value Increase in inventory to fair value (15,600) Increase in land to fair value (28,800) Increase in bond to fair value 45,050 Total increase in net assets to fair value Goodwill 2-5 $299,808 225,242 525,050 480,000 $ 45,050 $510,000 (373,200) 136,800 650 $137,450 Exercise 2-5 Current Assets Plant and Equipment Goodwill Liabilities Cash Liability for Contingent Consideration 960,000 1,440,000 336,000 216,000 2,160,000 360,000 Exercise 2-6 The amount of the contingency is $500,000 (10,000 shares at $50 per share) Part A Part B Goodwill Paid-in-Capital for Contingent Consideration 500,000 Paid-in-Capital for Contingent Consideration Common Stock ($10 par) Paid-In-Capital in Excess of Par 500,000 500,000 100,000 400,000 Platz Company does not adjust the original amount recorded as equity. Exercise 2-7 Current Assets Plant Assets (1) Goodwill (2) Debt Stockholders’ Equity (3) $3,000 24,350 23,400 50,000 750 (1) $12,000 + [.95 ($25,000 – $12,000)] = $24,350 (2) Cost of shares Book value of net assets acquired (.95$15,000) Excess of cost over book value Assigned to plant assets [.95$25,000 – $12,000)] Assigned to goodwill $50,000 14,250 35,750 12,350 $23,400 (3) .05$15,000 = 750 2-6 Exercise 2-8 1. (c) Cost (8,000 shares @ $30) Fair value of net assets acquired Excess of cost over fair value (goodwill) $240,000 228,800 $ 11,200 2. (c) Cost (8,000 shares @ $30) Fair value of net assets acquired ($90,000 + $242,000 – $56,000) Excess of fair value over cost (gain) $240,000 276,000 $ 36,000 Exercise 2-9 Current Assets Long-term Assets ($1,890,000 + $20,000) + ($98,000 + $5,000) Goodwill * Liabilities Long-term Debt Common Stock (144,000  $5) Other Contributed Capital (144,000 $15 – $5)) 362,000 2,013,000 395,000 * (144,000 $15) – [$362,000 + $2,013,000 – ($119,000 + $491,000)] = $395,000  $700,000 $20,000    = 144,000 $5   $5 Total shares issued  Fair value of stock issued (144,000$15) = $2,160,000 Exercise 2-10 Case A Cost (Purchase Price) Less: Fair Value of Net Assets Goodwill $130,000 120,000 $ 10,000 Case B Cost (Purchase Price) Less: Fair Value of Net Assets Goodwill $110,000 90,000 $ 20,000 Case C Cost (Purchase Price) Less: Fair Value of Net Assets Gain $15,000 20,000 ($ 5,000) 2-7 119,000 491,000 720,000 1,440,000 Exercise 2-10 (Continued) Case A Case B Case C Goodwill Assets Current Assets Long-Lived Assets $10,000 20,000 0 $20,000 30,000 20,000 $130,000 80,000 40,000 Liabilities $30,000 20,000 40,000 Exercise 2-11 Part A. 2008: Step 1: Fair value of the reporting unit Carrying value of unit: Carrying value of identifiable net assets $330,000 Carrying value of goodwill ($450,000 – $375,000) 75,000 Retained Earnings (Gain) 0 0 5,000 $400,000 405,000 $ 5,000 Excess of carrying value over fair value The excess of carrying value over fair value means that step 2 is required. Step 2: Fair value of the reporting unit Fair value of identifiable net assets Implied value of goodwill Recorded value of goodwill ($450,000 – $375,000) Impairment loss 2009: Step 1: Fair value of the reporting unit Carrying value of unit: Carrying value of identifiable net assets Carrying value of goodwill ($75,000 – $15,000) $400,000 340,000 60,000 75,000 $ 15,000 $400,000 $320,000 60,000 380,000 $ 20,000 Excess of fair value over carrying value The excess of fair value over carrying value means that step 2 is not required. 2010: Step 1: Fair value of the reporting unit Carrying value of unit: Carrying value of identifiable net assets Carrying value of goodwill ($75,000 – $15,000) $350,000 $300,000 60,000 Excess of carrying value over fair value The excess of carrying value over fair value means that step 2 is required. 2-8 360,000 $ 10,000 Exercise 2-11 (Continued) Step 2: Fair value of the reporting unit Fair value of identifiable net assets Implied value of goodwill Recorded value of goodwill ($75,000 – $15,000) Impairment loss Part B. 2008: Impairment Loss—Goodwill Goodwill 2009: No entry 2010: Impairment Loss—Goodwill Goodwill $350,000 325,000 25,000 60,000 $ 35,000 15,000 15,000 35,000 35,000 Part C. SFAS No. 142 specifies the presentation of goodwill in the balance sheet and income statement (if impairment occurs) as follows:  The aggregate amount of goodwill should be a separate line item in the balance sheet.  The aggregate amount of losses from goodwill impairment should be shown as a separate line item in the operating section of the income statement unless some of the impairment is associated with a discontinued operation (in which case it is shown net-of-tax in the discontinued operation section). Part D. In a period in which an impairment loss occurs, SFAS No. 142 mandates the following disclosures in the notes: (1) A description of the facts and circumstances leading to the impairment; (2) The amount of the impairment loss and the method of determining the fair value of the reporting unit; (3) The nature and amounts of any adjustments made to impairment estimates from earlier periods, if significant. Exercise 2-12 a. Fair Value of Identifiable Net Assets Book values $500,000 – $100,000 = Write up of Inventory and Equipment: ($20,000 + $30,000) = Purchase price above which goodwill would result $400,000 50,000 $450,000 b. Equipment would not be written down, regardless of the purchase price, unless it was reviewed and determined to be overvalued originally. c. A gain would be shown if the purchase price was below $450,000. d. Anything below $450,000 is technically considered a bargain. e. Goodwill would be $50,000 at a purchase price of $500,000 or ($450,000 + $50,000). Exercise 2-13A 2-9 Cash Accounts Receivable Inventory Land Plant Assets Discount on Bonds Payable Goodwill* Allowance for Uncollectible Accounts Accounts Payable Bonds Payable Deferred Income Tax Liability Cash 20,000 112,000 134,000 55,000 463,000 20,000 127,200 10,000 54,000 200,000 67,200 600,000 Cost of acquisition $600,000 Book value of net assets acquired ($80,000 + $132,000 + $160,000) 372,000 Difference between cost and book value 228,000 Allocated to: Increase inventory, land, and plant assets to fair value ($52,000 + $25,000 + $71,000) (148,000) Decrease bonds payable to fair value (20,000) Establish deferred income tax liability ($168,00040%) 67,200 Balance assigned to goodwill $127,200 Exercise 2-14B Revenues Expenses Income before depreciation and amortization Depreciation – equipment Depreciation – building Amortization of goodwill Income before taxes Pooling $300,000 (120,000) Purchase(old*) $300,000 (120,000) 180,000 (6,000) (5,000) ______ $ 169,000 180,000 (12,000) (12,500) (1,000) $ 154,500 Purchase (new) $300,000 (120,000) 180,000 (12,000) (12,500) -0$155,500 * “Old” refers to the period when goodwill was amortized for reporting purposes, i.e., before FASB Statement No. 141. Depreciation and amortization expense Equipment $60,000/10 yr = $6,000 $120,000/10 yrs = $12,000 Building $100,000/20 yrs = $5,000 Goodwill* * Cost Fair value of net assets Goodwill ANSWERS TO PROBLEMS $250,000/20 yrs = $12,500 ($40,000)/40 = $1,000 only under old rules $445,000 405,000 = ($435,000 – $30,000) $ 40,000 2 – 10 Problem 2-1 Current Assets Plant and Equipment Goodwill* Liabilities Common Stock [(20,000 shares @ $10/share)] Other Contributed Capital [(20,000($15 – $10))] 85,000 150,000 100,000 Acquisition Costs Expense Cash 20,000 Other Contributed Capital Cash To record the direct acquisition costs and stock issue costs 6,000 35,000 200,000 100,000 20,000 6,000 * Goodwill = Excess of Consideration of $335,000 (stock valued at $300,000 plus debt assumed of $35,000) over Fair Value of Identifiable Assets of $235,000 (total assets of $225,000 plus PPE fair value adjustment of $10,000) Problem 2-2 Acme Company Balance Sheet October 1, 2008 (000) Part A. Assets (except goodwill) ($3,900 + $9,000 + $1,300) Goodwill (1) Total Assets $14,200 1,160 $15,360 Liabilities ($2,030 + $2,200 + $260) Common Stock (180$20) + $2,000 Other Contributed Capital (180($50 – $20)) Retained Earnings Total Liabilities and Equity $4,490 5,600 5,400 (130) $15,360 (1) Cost (180$50) Fair value of net assets acquired: $9,000 $10,300 2,460 Fair value of assets of Baltic and Colt Less liabilities assumed Goodwill 2 – 11 7,840 $1,160 Problem 2-2 (continued) Part B. Baltic 2009: Step1: Fair value of the reporting unit $6,500,000 Carrying value of unit: Carrying value of identifiable net assets 6,340,000 Carrying value of goodwill 200,000* Total carrying value 6,540,000 *[(140,000 x $50) – ($9,000,000 – $2,200,000)] The excess of carrying value over fair value means that step 2 is required. Step 2: Fair value of the reporting unit Fair value of identifiable net assets Implied value of goodwill Recorded value of goodwill Impairment loss $6,500,000 6,350,000 150,000 200,000 $ 50,000 (because $150,000 < $200,000) Colt 2009: Step1: Fair value of the reporting unit $1,900,000 Carrying value of unit: Carrying value of identifiable net assets $1,200,000 Carrying value of goodwill 960,000* Total carrying value 2,160,000 *[(40,000 x $50) – ($1,300,000 – $260,000)] The excess of carrying value over fair value means that step 2 is required. Step 2: Fair value of the reporting unit Fair value of identifiable net assets Implied value of goodwill Recorded value of goodwill Impairment loss $1,900,000 1,000,000 900,000 960,000 $ 60,000 (because $900,000 < $960,000) Total impairment loss is $110,000. Journal entry: Impairment Loss Goodwill $110,000 $110,000 2 – 12 Problem 2-3 Present value of maturity value, 20 periods @ 6%: 0.3118$600,000 = Present value of interest annuity, 20 periods @ 6%: 11.46992$30,000 = Total Present value Par value Discount on bonds payable Cash Accounts Receivable Inventory Land Buildings Equipment Bond Discount ($40,000 + $68,822) Current Liabilities Bonds Payable ($300,000 + $600,000) Gain on Purchase of Business $187,080 344,098 531,178 600,000 $68,822 114,000 135,000 310,000 315,000 54,900 39,450 108,822 95,300 900,000 81,872 Computation of Excess of Net Assets Received Over Cost Cost (Purchase Price) ($531,178 plus liabilities assumed of $95,300 and $260,000) Less: Total fair value of assets received Excess of fair value of net assets over cost $886,478 $968,350 ($ 81,872) Problem 2-4 Part A January 1, 2008 Accounts Receivable Inventory Land Buildings Equipment Goodwill* Allowance for Uncollectible Accounts Accounts Payable Note Payable Cash Liability for Contingent Consideration *Computation of Goodwill Cash paid ($720,000 + $135,000) Total fair value of net assets acquired ($1,064,000 – $263,000) Goodwill 2 – 13 72,000 99,000 162,000 450,000 288,000 54,000 7,000 83,000 180,000 720,000 135,000 $855,000 801,000 $ 54,000 Problem 2-4 (continued) Part B January 2, 2010 Liability for Contingent Consideration Cash 135,000 135,000 Part C January 2, 2010 Liability for Contingent Consideration Income from Change in Estimate 135,000 135,000 Problem 2-5 Part A Investment in Park Company (5% of book value) Common Stock 2,000 2,000 Cash 90,000 Notes Payable 90,000 Investment in Park Company Cash 80,000 Current Assets Plant Assets (1) Goodwill (2) Liabilities Investment in Park 12,000 68,250 8,750 80,000 7,000 82,000 (1) $35,000 + .95$70,000 – $35,000) = $68,250 (2) Cost of shares Book value of net assets (.95$40,000) = Difference between cost and book value Allocated to: Plant assets (.95 ($70,000 – $35,000)) = Goodwill $80,000 38,000 $ 42,000 2 – 14 33,250 $ 8,750 Problem 2-5 (continued) Part B Step Company Balance Sheet January 1, 2007 Current Assets ($12,000 + $10,000) Plant Assets ($35,000 + $33,250) Goodwill Total Assets $22,000 68,250 8,750 $ 99,000 Liabilities Note Payable Common Stock Total Liabilities and Stockholders’ Equity $7,000 90,000 2,000 $ 99,000 Problem 2-6 Pepper Company Pro Forma Balance Sheet Giving Effect to Proposed Issue of Common Stock and Note Payable for All of the Common Stock of Salt Company under Purchase Accounting December 31, 2007 Cash Receivables Audited Balance Sheet $180,000 230,000 Inventories Plant Assets Goodwill Total Assets 231,400 1,236,500 _________ $1,877,900 Accounts Payable $255,900 Notes Payable, 8% Mortgage Payable Common Stock, $20 par Additional Paid-in Capital Retained Earnings Total Liabilities and Equity 0 180,000 900,000 270,000 272,000 $1,877,900 2 – 15 Adjustments 405,000 (60,000) 117,000 134,000 905,000 (1) 181,500 (60,000) 180,000 300,000 152,500 600,000 510,000 (2) Pro Forma Balance Sheet $585,000 287,000 365,400 2,141,500 181,500 $3,560,400 $375,900 300,000 332,500 1,500,000 780,000 272,000 $3,560,400 Problem 2-6 (continued) Change in Cash Cash from stock issue ($3730,000) Less: Cash paid for acquisition Plus: Cash acquired in acquisition Total change in cash $1,110,000 (800,000) 95,000 $ 405,000 Goodwill: Cost of acquisition Net assets acquired ($340,000 + $179,500 + $184,000) Excess cost over net assets acquired Assigned to plant assets Goodwill (1) $690,000 + $215,000 Problem 2-7 $1,100,000 703,500 $396,500 215,000 $ 181,500 (2) ($37- $20) 30,000 Ping Company Pro Forma Income Statement for the Year 2008 Assuming a Merger of Ping Company and Spalding Company Sales (1) Cost of goods sold: Fixed Costs (2) Variable Costs (3) Gross Margin $6,345,972 $824,706 2,464,095 Selling Expenses (4) Other Expenses (5) $785,910 319,310 Net Income 3,288,801 3,057,171 1,105,220 $1,951,951 $499,411 $1,951,951 – ($952,640 + $499,900) = = $2,497,055 0 . 20 0.20 Since $2,497,055 is greater than $1,800,000 Ping should buy Spalding. (1) $3,510,100 + $2,365,800 = $5,875,9001.2.9 = (2) ($1,752,360.30) + ($1,423,800.30.70) = (3) $1,752,360.70 $5,875,900  1.2 $3,510,100 = $6,345,972 $824,706 $2,464,095 (4) ($632,500 + $292,100).85 = $785,910 (5) $172,6001.85 = $319,310 2 – 16 Problem 2-8A Part A Receivables Inventory Land Plant Assets Patents Deferred Tax Asset ($60,000 x 35%) Goodwill* Current Liabilities Bonds Payable Premium on Bonds Payable Deferred Tax Liability Common Stock (30,000$2) Other Contributed Capital (30,000$26) Cost of acquisition (30,000$28) Book value of net assets acquired ($120,000 + $164,000 + $267,000) Difference between cost and book value Allocated to: Increase inventory, land, plant assets, and patents to fair value Deferred income tax liability (35%$266,500) Increase bonds payable to fair value Deferred income tax asset (35%$60,000) Balance assigned to goodwill Part B Income Tax Expense (Balancing amount) Deferred Tax Liability ($51,12535%)* Deferred Tax Asset ($6,00035%) Income Tax Payable ($468,00035%) * Inventory: $100,000 10 $105,000 Patents, 8 Plant Assets, Total $28,000 10,000 13,125 $51,125 2 – 17 125,000 195,000 120,000 567,000 200,000 21,000 154,775 89,500 300,000 60,000 93,275 60,000 780,000 $840,000 551,000 289,000 (266,500) 93,275 60,000 (21,000) $154,775 148,006 17,894 2,100 163,800