INTERCORPORATE ACQUISITION S AND INVESTMENTS IN OTHER ENTITIES

1-1 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

CHAPTER 1

INTERCORPORATE ACQUISITION S AND INVESTMENTS IN OTHER ENTITIES

ANSWERS TO QUESTIONS

Q1-1 Complex organizational structures often result when companies do business in a complex business environment. New subsidiaries or other entities may be formed for purposes such as extending operations into foreign countries, seeking to protect existing assets from risks associated with entry into new product lines, separating activities that fall under regulatory controls, and reducing taxes by separating certain types of operations.Q1-2 The split-off and spin-off result in the same reduction of reported assets and liabilities. Only the stockholders’ equity accounts of the company are different. The number of shares outstanding remains unchanged in the case of a spin-off and retained earnings or paid-in capital is reduced.Shares of the parent are exchanged for shares of the subsidiary in a split-off, thereby reducing the outstanding shares of the parent company.Q1-3 Enron’s management used special-purpose entities to avoid reporting debt on its balance sheet and to create fictional transactions that resulted in reported income. It also transferred bad loans and investments to special-purpose entities to avoid recognizing losses in its income statement.Q1-4 (a) A statutory merger occurs when one company acquires another company and the assets and liabilities of the acquired company are transferred to the acquiring company; the acquired company is liquidated, and only the acquiring company remains. The acquiring company can give cash or other assets in addition to stock.(b)A statutory consolidation occurs when a new company is formed to acquire the assets and liabilities of two combining companies. The combining companies dissolve, and the new company is the only surviving entity.(c)A stock acquisition occurs when one company acquires a majority of the common stock of another company and the acquired company is not liquidated; both companies remain as separate but related corporations.Q1-5 A noncontrolling interest exists when the acquiring company gains control but does not own all the shares of the acquired company. The non-controlling interest is made up of the shares not owned by the acquiring company.Q1-6 Goodwill is the excess of the sum of (1) the fair value given by the acquiring company, (2) the fair value of any shares already owned by the parent and (3) the acquisition-date fair value of any noncontrolling interest over the acquisition-date fair value of the net identifiable assets acquired in the business combination.Q1-7 A differential is the total difference at the acquisition date between the sum of (1) the fair value given by the acquiring company, (2) the fair value of any shares already owned by the parent and (3) the acquisition-date fair value of any noncontrolling interest and the book value of the net identifiable assets acquired is referred to as the differential.Advanced Financial Accounting 12e Theodore Christensen David Cottrell Richard Baker (Solutions Manual All Chapters, 100% Original Verified, A+ Grade) All Chapters Solutions Manual Supplement files download link at the end of this file. 1 / 4

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities 1-2 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Q1-8 The purchase of a company is viewed in the same way as any other purchase of assets.The acquired company is owned by the acquiring company only for the portion of the year subsequent to the combination. Therefore, earnings are accrued only from the date of purchase forward.Q1-9 None of the retained earnings of the subsidiary should be carried forward under the acquisition method. Thus, consolidated retained earnings immediately following an acquisition is limited to the balance reported by the acquiring company.Q1-10 Additional paid-in capital reported following a business combination is the amount previously reported on the acquiring company's books plus the excess of the fair value over the par or stated value of any shares issued by the acquiring company in completing the acquisition less any sock issue costs.Q1-11 When the acquisition method is used, all costs incurred in bringing about the combination are expensed as incurred. None are capitalized. However, costs associated with the issuance of stock are recorded as a reduction of additional paid-in capital.Q1-12 When the acquiring company issues shares of stock to complete a business combination, the excess of the fair value of the stock issued over its par value is recorded as additional paid-in capital. All costs incurred by the acquiring company in issuing the securities should be treated as a reduction in the additional paid-in capital. Items such as audit fees associated with the registration of the new securities, listing fees, and brokers' commissions should be treated as reductions of additional paid-in capital when stock is issued.Q1-13 If the fair value of a reporting unit acquired in a business combination exceeds its carrying amount, the goodwill of that reporting unit is considered unimpaired. On the other hand, if the carrying amount of the reporting unit exceeds its fair value, impairment of goodwill is implied. An impairment must be recognized if the carrying amount of the goodwill assigned to the reporting unit is greater than the implied value of the carrying unit’s goodwill. The implied value of the reporting unit’s goodwill is determined as the excess of the fair value of the reporting unit over the fair value of its net identifiable assets.Q1-14 A bargain purchase occurs when the fair value of the consideration given in a business combination, along with the fair value of any equity interest in the acquiree already held and the fair value of any noncontrolling interest in the acquiree, is less than the fair value of the acquiree’s net identifiable assets.Q1-15 The acquirer should record the clarification of the acquisition-date fair value of buildings as a reduction to buildings and addition to goodwill..Q1-16 The acquirer must revalue the equity position to its fair value at the acquisition date and recognize a gain. A total of $250,000 ($25 x 10,000 shares) would be recognized in this case assuming that the $65 per share price is the appropriate fair value for all shares (i.e. there is no control premium for the new shares purchased). 2 / 4

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

1-3 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

SOLUTIONS TO CASES

C1-1 Assignment of Acquisition Costs

MEMO

To: Vice-President of Finance

Troy Company

From: , CPA

Re: Recording Acquisition Costs of Business Combination

Troy Company incurred a variety of costs in acquiring the ownership of Kline Company and transferring the assets and liabilities of Kline to Troy Company. I was asked to review the relevant accounting literature and provide my recommendations as to what was the appropriate treatment of the costs incurred in the Kline Company acquisition.

Current accounting standards require that acquired companies be valued under ASC 805 at the fair value of the consideration given in the exchange, plus the fair value of any shares of the acquiree already held by the acquirer, plus the fair value of any noncontrolling interest in the acquiree at the combination date [ASC 805]. All other acquisition-related costs directly traceable to an acquisition should be accounted for as expenses in the period incurred [ASC 805]. The costs incurred in issuing common or preferred stock in a business combination are required to be treated as a reduction of the recorded amount of the securities (which would be a reduction to additonal paid-in capital if the stock has a par value or a reduction to common stock for no par stock).

A total of $720,000 was paid in completing the Kline acquisition. Kline should record the $200,000 finders’ fee and $90,000 legal fees for transferring Kline’s assets and liabilities to Troy as acquisition expense in 20X7. The $60,000 payment for stock registration and audit fees should be recorded as a reduction of paid-in capital recorded when the Troy Company shares are issued to acquire the shares of Kline. The only cost potentially at issue is the $370,000 legal fees resulting from the litigation by the shareholders of Kline. If this cost is considered to be a direct acquisition cost, it should be included in acquisition expense. If, on the other hand, it is considered to be related to the issuance of the shares, it should be debited to paid-in capital.

Primary citation

ASC 805

C1-2 Evaluation of Merger

• AT&T had a vast cable customer base, but felt that TimeWarner’s content would greatly

enhance the demand for its cable services.

• AT&T provided TimeWarner shareholders with AT&T stock and an equal value of cash.

• The cash portion of the merger was funded primarily with debt.
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Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

1-4 Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

• This would be a statutory merger since (1) the AT&T name survived through the merger and

(2) the acquisition was formalized when AT&T gave both stock and cash.C1-3 Business Combinations

It is very difficult to develop a single explanation for any series of events. Merger activity in the United States is impacted by events both within the U.S. economy and those around the world.As a result, there are many potential answers to the questions posed in this case.

• One factor that may have prompted the greater use of stock in business combinations in the

middle and late 1990s is that many of the earlier combinations that had been effected through the use of debt had unraveled. In many cases, the debt burden was so heavy that the combined companies could not meet debt payments. Thus, this approach to financing mergers had somewhat fallen from favor by the mid-nineties. Further, with the spectacular rise in the stock market after 1994, many companies found that their stock was worth much more than previously.Accordingly, fewer shares were needed to acquire other companies.

• Two of major factors appear to have had a significant influence on the merger movement in the

mid-2000s. First, interest rates were very low during that time, and a great amount of unemployed cash was available worldwide. Many business combinations were effected through significant borrowing. Second, private equity funds pooled money from various institutional investors and wealthy individuals and used much of it to acquire companies.

Many of the acquisitions of this time period involved private equity funds or companies that acquired other companies with the goal of making quick changes and selling the companies for a profit. This differed from prior merger periods where acquiring companies were often looking for long-term acquisitions that would result in synergies.

In late 2008, a mortgage crisis spilled over into the credit markets in general, and money for acquisitions became hard to get. This in turn caused many planned or possible mergers to be canceled. In addition, the economy in general faltered toward the end of 2008 and into 2009.Since that time, companies have turned their attention to global expansion.

• Establishing incentives for corporate mergers is a controversial issue. Many people in our

society view mergers as not being in the best interests of society because they are seen as lessening competition and often result in many people losing their jobs. On the other hand, many mergers result in companies that are more efficient and can compete better in a global economy; this in turn may result in more jobs and lower prices. Even if corporate mergers are viewed favorably, however, the question arises as to whether the government, and ultimately the taxpayers, should be subsidizing those mergers through tax incentives. Many would argue that the desirability of individual corporate mergers, along with other types of investment opportunities, should be determined on the basis of the merits of the individual situations rather than through tax incentives.

Perhaps the most obvious incentive is to lower capital gains tax rates. Businesses may be more likely to invest in other companies if they can sell their ownership interests when it is convenient and pay lesser tax rates. Another alternative would include exempting certain types of intercorporate income. Favorable tax status might be given to investment in foreign companies through changes in tax treaties. As an alternative, barriers might be raised to discourage foreign investment in United States, thereby increasing the opportunities for domestic firms to acquire ownership of other companies.

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