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Chapter 1 Introduction to Business Combinations and the Conceptual Framework Multiple Choice 1. Stock given given as consi considerat deration ion for for a business business combin combination ation is is valued valued at a. fair market value b. par value c. historical cost d. None of the above
2. Which of the the following following situatio situations ns best describe describess a business business combination combination to be account accounted ed for as a statutory merger? a. Both companie companiess in a combination combination continue continue to operate operate as separate separate but but related related legal entities entities.. b. !nly one of the combining combining companies survives survives and the other loses its its separate identity. identity. c. "wo "wo companies companies combin combinee to form a new third third company company and the origin original al two companie companiess are dissolved. d. !ne compan company y transfers transfers assets assets to anoth another er company company it has created created.. #. $ firm can use use which method of financing for for an ac%uisition ac%uisition structured structured as either an asset asset or stock stock ac%uisition? a. &ash b. 'ssuing (ebt c. 'ssuing St Stock d. $ll of of the the abov abovee ). "he ob*ectives ob*ectives of +$SB +$SB 1)1, 1)1, -Business &ombinations and +$SB +$SB 1/0 -Noncontrolling -Noncontrolling 'nterests in &onsolidated +inancial Statements are as follows a. to improve improve the relevance relevance comparabili comparability ty and transparency transparency of financial financial informati information on related related to business combinations. combinations. b. to eliminate the amortiation amortiation of 3oodwill. 3oodwill. c. to facilitate facilitate the convergence pro*ect of of the +$SB +$SB and the 'nternational 'nternational $ccounting $ccounting Standards Board. d. a and b only 4. $ business combination in which the boards of directors of the potential potential combining combining companies companies negotiate negotiate mutually agreeable terms is a-n a. agre agreea eabl blee comb combin inat atio ion. n. b. friendly combination. combination. c. host hostil ilee comb combin inat atio ion. n. d. unfr unfrie iend ndly ly comb combin inat atio ion. n. /. $ merger merger between between a supp supplier lier and and a customer customer is a-n a. frie friend ndly ly comb combin inat atio ion. n. b. horiontal combination. combination. c. unfr unfrie iend ndly ly comb combin inat atio ion. n. d. vert vertic ical al comb combin inat atio ion. n. 5. "he impairm impairment ent standard standard as it it relates relates to goodwi goodwill ll is an e6amp e6ample le of a a. consum consumpti ption on of benefi benefitt appr approac oach. h. b. loss or lack of benefit approach. approach. c. compon component ent of of other other compr comprehe ehensi nsive ve incom income. e.
182
Test Bank to accompany Jeter and Chaney Advanced Accounting
d. direct matching of e6penses to revenues. 7. "he defense tactic that involves purchasing shares held by the would8be ac%uiring company at a price substantially in e6cess of their fair value is called a. poison pill. b. pac8man defense. c. greenmail. d. white knight. 9. "he third period of business combinations started after World War '' and is called a. horiontal integration. b. merger mania. c. operating integration. d. vertical integration. 10. Which of the following is not a component of other comprehensive income under 3$$:? a. earnings. b. gains and losses that bypass earnings. c. impairment losses. d. accumulated other comprehensive income. 11. When a new corporation is formed to ac%uire two or more other corporations and the ac%uired corporations cease to e6ist as separate legal entities the result is a statutory a. ac%uisition. b. combination. c. consolidation. d. merger. 12. "he e6cess of the amount offered in an ac%uisition over the prior stock price of the ac%uired firm is the a. bonus. b. goodwill. c. implied offering price. d. takeover premium. 1#. "he difference between normal earnings and e6pected future earnings is a. average earnings. b. e6cess earnings. c. ordinary earnings. d. target earnings. 1). "he first step in estimating goodwill in the e6cess earnings approach is to a. determine normal earnings. b. identify a normal rate of return for similar firms. c. compute e6cess earnings. d. estimate e6pected future earnings. 14. ;any of +$SB
+ull file at http==testbankinstant.&>="est8Bank8for8$dvanced8$ccounting84th8 dition8by8@eter 1/. stimated goodwill is determined by computing the present value of the a. average earnings. b. e6cess earnings. c. e6pected future earnings. d. normal earnings. 15. Which of the following statements would not be a valid or logical reason for entering into a business combination? a. to increase market share. b. to avoid becoming a takeover target. c. to reduce risk by ac%uiring established product lines. d. the operating costs of the combined entity would be more than the sum of the separate entities. 17. "he parent company concept of consolidation represents the view that the primary purpose of consolidated financial statements is a. to provide information relevant to the controlling stockholders. b. to represent the view that the affiliated companies are a separate identifiable economic entity. c. to emphasis control of the whole by a single management. d. to include only a portion of the subsidiary
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18)
Test Bank to accompany Jeter and Chaney Advanced Accounting
c. creditors. d. both ma*ority and minority stockholders. 2). Which of the following statements is correct? a. "he economic unit concept suggests partial elimination of unrealied intercompany profits. b. "he parent company concept suggests partial elimination of unrealied intercompany profits. c. "he economic unit concept suggests no elimination of unrealied intercompany profits. d. "he parent company concept suggests total elimination of unrealied intercompany profits. 24. When following the parent company concept in the preparation of consolidated financial statements noncontrolling interest in combined income is considered a-n a. prorated share of the combined income. b. addition to combined income to arrive at consolidated net income. c. e6pense deducted from combined income to arrive at consolidated net income. d. deduction from current assets in the balance sheet. 2/. When following the economic unit concept in the preparation of consolidated financial statements the basis for valuing the noncontrolling interest in net assets is the a. book values of subsidiary assets and liabilities. b. fair values of subsidiary assets and liabilities. c. general price level ad*usted values of subsidiary assets and liabilities. d. fair values of parent company assets and liabilities. 25. "he view that consolidated financial statements represent those of a single economic entity with several classes of stockholder interest is consistent with the a. parent company concept. b. current practice concept. c. historical cost company concept. d. economic unit concept. 27. "he view that the noncontrolling interest in income reflects the noncontrolling stockholdersC allocated share of consolidated income is consistent with the a. economic unit concept. b. parent company concept. c. current practice concept. d. historical cost company concept. 29. "he view that only the parent companyCs share of the unrealied intercompany profit recognied by the selling affiliate that remains in assets should be eliminated in the preparation of consolidated financial statements is consistent with the a. economic unit concept. b. current practice concept. c. parent company concept. d. historical cost company concept. Problems
181
>opkins &ompany is considering the ac%uisition of ,ichfield 'nc. "o assess the amount it might be willing to pay >opkins makes the following computations and assumptions. $. ,ichfield 'nc. has identifiable assets with a total fair value of D/000000 and liabilities of D#500000. "he assets include office e%uipment with a fair value appro6imating book value
+ull file at http==testbankinstant.&>="est8Bank8for8$dvanced8$ccounting84th8 dition8by8@eter buildings with a fair value 24E higher than book value and land with a fair value 40E higher than book value. "he remaining lives of the assets are deemed to be appro6imately e%ual to those used by ,ichfield 'nc. B. ,ichfield 'nc.Cs preta6 incomes for the years 2011 through 201# were D)50000 D450000 and D#50000 respectively. >opkins believes that an average of these earnings represents a fair estimate of annual earnings for the indefinite future. >owever it may need to consider ad*ustments for the following items included in preta6 earnings (epreciation on Buildings -each year (epreciation on %uipment -each year 6traordinary Foss -year 201# Salary 6pense -each year
#70000 #0000 1#0000 150000
&. "he normal rate of return on net assets for the industry is 14E. Reuired $. $ssume that >opkins feels that it must earn a 20E return on its investment and that goodwill is determined by capitaliing e6cess earnings. Based on these assumptions calculate a reasonable offering price for ,ichfield 'nc. 'ndicate how much of the price consists of goodwill. B. $ssume that >opkins feels that it must earn a 14E return on its investment but that average e6cess earnings are to be capitalied for five years only. Based on these assumptions calculate a reasonable offering price for ,ichfield 'nc. 'ndicate how much of the price consists of goodwill.
182
den &ompany is trying to decide whether to ac%uire Bloomington 'nc. "he following balance sheet for Bloomington 'nc. provides information about book values. stimated market values are also listed based upon den &ompanyCs appraisals. Bloomington 'nc. Book Galues
Bloomington 'nc. ;arket Galues
&urrent $ssets :roperty :lant H %uipment -net "otal $ssets
D )40000 11)0000 D1490000
D )40000 1#00000 D1540000
"otal Fiabilities &ommon Stock D10 par value ,etained arnings "otal Fiabilities and %uities
D500000 270000 /10000 D1490000
D500000
den &ompany e6pects that Bloomington will earn appro6imately D290000 per year in net income over the ne6t five years. "his income is higher than the 1)E annual return on tangible assets considered to be the industry Inorm.I Reuired $. &ompute an estimation of goodwill based on the information above that den might be willing to pay -include in its purchase price under each of the following additional assumptions -1 den is willing to pay for excess earnings for an e6pected life of ) years -undiscounted. -2 den is willing to pay for excess earnings for an e6pected life of ) years which should be capitalied at the industry normal rate of return.
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18/
Test Bank to accompany Jeter and Chaney Advanced Accounting
-# 6cess earnings are e6pected to last indefinitely but den demands a higher rate of return of 20E because of the risk involved. (etermine the amount of goodwill to be recorded on the books if den pays D1#00000 cash and assumes BloomingtonCs liabilities.
B.
18#
:ark &ompany ac%uired an 70E interest in the common stock of Southdale &ompany for D14)0000 on @uly 1 201#. Southdale &ompanyCs stockholdersC e%uity on that date consisted of &ommon stock !ther contributed capital ,etained earnings
D700000 )00000 ##0000
Reuired &ompute the total noncontrolling interest to be reported in the consolidated balance sheet assuming the -1 parent company concept. -2 economic unit concept.
18)
"he following balances were taken from the records of S &ompany &ommon stock -1=1=1# and 12=#1=1# ,etained earnings 1=1=1# Net income for 201# (ividends declared in 201# ,etained earnings 12=#1=1# "otal stockholdersC e%uity on 12=#1=1#
: &ompany purchased 54E of S &ompanyCs common stock on @anuary 1 2011 for D900000. "he difference between implied value and book value is attributable to assets with a remaining useful life on @anuary 1 201# of ten years. Reuired
$. &ompute the difference between cost=-implied and book value applying 1. :arent company theory. 2. conomic unit theory. B. $ssuming the economic unit theory 1. &ompute noncontrolling interest in consolidated income for 201#. 2. &ompute noncontrolling interest in net assets on (ecember #1 201#. Short Answer
1.
stimating the value of goodwill to be included in an offering price can be done under several alternative methods. "he e6cess earnings approach is fre%uently used. 'dentify the steps used in this approach to estimate goodwill.
2.
"he two alternative views of consolidated financial statements are the parent company concept and the economic entity concept. Briefly e6plain the differences between the concepts.
+ull file at http==testbankinstant.&>="est8Bank8for8$dvanced8$ccounting84th8 dition8by8@eter !hort Answer "uestions in Te#tbook the $mistakes$ with spacing appeared on my printed %iles& but not here& so I will '(T attempt to make changes 1. (istinguish between internal and e6ternal e6pansion of a firm.
2. Fist four advantages of a business combination as compared to internal e6pansion. #. What is the primary legal constraint on business combinations? Why does such a constraint e6ist? ). Business combinations may be classified into three types based upon the relationships among the combining entities -e.g. combinations with suppliers customers competitors etc.. 'dentify and define these types. 4. (istinguish among a statutory merger a statutory consolidation and a stock ac%uisition. /. (efine a tender offer and describe its use. 5. When stock is e6changed for stock in a business combination how is the stock e6change ratio generally e6pressed? 7. (efine some defensive measures used by target firms to avoid a takeover. $re these measures beneficial for shareholders? 9. 6plain the potential advantages of a stock ac%uisition over an asset ac%uisition. 10. 6plain the difference between an accretive and a dilutive ac%uisition. 11. (escribe the difference between the economic entity concept and the parent company concept approaches to the reporting of subsidiary assets and liabilities in the consolidated financial statements on the date of the ac%uisition. 12. &ontrast the consolidated effects of the parent company concept and the economic entity con8cept concept in terms of -a"he treatment of noncontrolling interests. -b"he elimination of intercompany profits. -c"he valuation of subsidiary net assets in the consolidated financial statements. -d"he definition of consolidated net income. 1#. Ander the economic entity concept the net as8sets assets of the subsidiary are included in the consolidated financial statements at the total fair value that is implied by the price paid by the parent company for its controlling interest. What practical or conceptual problems do you see in this approach to valuation? 1). 's the economic entity or the parent concept more consistent with the principles addressed in the +$SBow does the +$SB
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187
Test Bank to accompany Jeter and Chaney Advanced Accounting
Business )thics "uestions %rom the Te#tbook
+rom 1999 to 2001 "yco
$ssume that all three items can be managed within the rules provided by 3$$: -* but would be regarded by many as pushing the limits of 3$$:.'s there an ethical issue? (escribe your position as -$ an accountant for the target company and -B as an accountant for "yco.
+ull file at http==testbankinstant.&>="est8Bank8for8$dvanced8$ccounting84th8 dition8by8@eter A'!.)R /)0
Multiple Choice
1. 2. #. ). 4. /. 5. 7.
a b d d b d b c
9. 10. 11. 12. 1#. 1). 14. 1/.
b d c d b b c b
15. 17. 19. 20. 21. 22. 2#. 2).
d a c a c b d b
24. 2/. 25. 27. 29.
c b d a c
Problems
181 $.
Normal earnings for similar firms J -D/000000 8 D#500000 K 14E J D#)4000 6pected earnings of target :reta6 income of ,ichfield 'nc. 2011 Subtract $dditional depreciation on buildings -D#70000 K .24 "argetCs ad*usted earnings 2011
D)50000 -94000 #54000
:reta6 income of ,ichfield 'nc. 2012 Subtract $dditional depreciation on buildings "argetCs ad*usted earnings 2012
D450000 -94000
:reta6 income of ,ichfield 'nc. 201# $dd 6traordinary loss Subtract $dditional depreciation on buildings "argetCs ad*usted earnings 201#
D#50000 1#0000 -94000
)54000
)04000
"argetCs three year total ad*usted earnings "argetCs three year average ad*usted earnings
1244000 )17###
6cess earnings of target J D)17### L D#)4000 J D5#### per year D5#### :resent value of e6cess earnings -perpetuity at 20E 20E J D#////4 -stimated 3oodwill 'mplied offering price J D/000000 8 D#500000 M D#////4 J 2/////4. B.
6cess earnings of target -same as in $ D5#### :resent value of e6cess earnings -ordinary annuity for five years at 14E D5#### K #.#421/ J D2)472) 'mplied offering price J D/000000 8 D#500000 M D2)472) J D24)472).
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1810 Test Bank to accompany Jeter and Chaney Advanced Accounting 'ote "he salary e6pense and depreciation on e%uipment are e6pected to continue at the same rate and thus do not necessitate ad*ustments.
182 $.
Normal earnings for similar firms -based on tangible assets only J D1540000 K 1)E J D2)4000 6cess earnings J D290000 8 2)4000 J D)4000
B.
-1
3oodwill based on four years e6cess earnings undiscounted. 3oodwill J -D)4000-) years J D170000
-2
3oodwill based on four years discounted e6cess earnings 3oodwill J -D)4000-2.91#51 J D1#1115 -present value of an annuity factor for nJ) 'J1)E is 2.91#51
-#
3oodwill based on a perpetuity 3oodwill J -D)4000=.20 J D224000
3oodwill J &ost less fair value of net assets 3oodwill J -D1#00000 8 -D1540000 8 D500000 J D240000
18# 1. "otal book value of SouthdaleCs net assets -D700000 M D)00000 M D##0000 Noncontrolling interest E Noncontrolling interest in net assets
D14#0000 K .2 D#0/000
2. "otal fair value of SouthdaleCs net assets -D14)0000=.7 D1924000 Noncontrolling interest E K .2 Noncontrolling interest in net assets D#74000
18) $1. &ost of investment %uity ac%uired .54-D520000 M D1/0000 (ifference -parent company theory 2. 'mplied value of S &ompany -D900000=.54 Book value of S &ompany -D520000 M D1/0000 (ifference -economic unit theory B1. Noncontrolling interest in consolidated income .24OD170000 8 -D#20000=10P 2. Noncontrolling interest in net assets .24OD1020000 M -9=10 K D#20000P
+ull file at http==testbankinstant.&>="est8Bank8for8$dvanced8$ccounting84th8 dition8by8@eter Short Answer
1.
"he e6cess earnings approach to estimating goodwill includes the following steps a. 'dentify a normal rate of return for firms similar to the company being targeted b. $pply the identified rate of return of the level of identifiable assets -or net assets of the target to appro6imate what would be normal earnings in this industry c. stimate the e6pected future earnings of the target d. Subtract the normal earnings from the e6pected target earnings to compute Qe6cess earningsR e. $ssume an appropriate time period and a discount rate to compute the discounted value of the e6cess earnings the estimated goodwill.
2.
Ander the parent company concept the consolidated financial statements reflect the stockholders< interests in the parent plus their undivided interests in the net assets of the parentCs subsidiaries. "he focus is on the interests of the parentCs shareholders. Ander the economic entity concept control of the whole by a single management is emphasied. With this concept consolidated financial statements are intended to provide information about a group of legal entities a parent company and its subsidiaries operating as a single unit.
!hort Answer "uestions %rom the Te#tbook !olutions
1. 'nternal e6pansion involves a normal increase in business resulting from increased demand for products and services achieved without ac%uisition of pree6isting firms. Some companies e6pand internally by undertaking new product research to e6pand their total market or by attempting to obtain a greater share of a given market through advertising and other promotional activities. ;arketing can also be e6panded into new geographical areas. 6ternal e6pansion is the bringing together of two or more firms under common control by ac%uisition. ,eferred to as business combinations these combined operations may be integrated or each firm may be left to operate intact. 2. +our advantages of business combinations as compared to internal e6pansion are -1 ;anagement is provided with an established operating unit with its own e6perienced personnel regular suppliers productive facilities and distribution channels. -2 6panding by combination does not create new competition. -# :ermits rapid diversification into new markets. -) 'ncome ta6 benefits.
#. "he primary legal constraint on business combinations is that of possible antitrust suits. "he Anited States government is opposed to the concentration of economic power that may result from business combinations and has enacted two federal statutes the Sherman $ct and the &layton $ct to deal with antitrust problems. ). -1 $ horiontal combination involves companies within the same industry that have previously been competitors. -2 Gertical combinations involve a company and its suppliers and=or customers. -# &onglomerate combinations involve companies in unrelated industries having little production or market similarities.
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1812 Test Bank to accompany Jeter and Chaney Advanced Accounting 4. $ statutory merger results when one company ac%uires all of the net assets of one or more other companies through an e6change of stock payment of cash or property or the issue of debt instruments. "he ac%uiring company remains as the only legal entity and the ac%uired company ceases to e6ist or remains as a separate division of the ac%uiring company. $ statutory consolidation results when a new corporation is formed to ac%uire two or more corporations through an e6change of voting stock with the ac%uired corporations ceasing to e6ist as separate legal entities. $ stock ac%uisition occurs when one corporation issues stock or debt or pays cash for all or part of the voting stock of another company. "he stock may be ac%uired through market purchases or through direct purchase from or e6change with individual stockholders of the investee or subsidiary company. /. $ tender offer is an open offer to purchase up to a stated number of shares of a given corporation at a stipulated price per share. "he offering price is generally set above the current market price of the shares to offer an additional incentive to the prospective sellers. 5. $ stock e6change ratio is generally e6pressed as the number of shares of the ac%uiring company that are to be e6changed for each share of the ac%uired company. 7. (efensive tactics include -1 :oison pill L when stock rights are issued to e6isting stockholders that enable them to purchase additional shares at a price below market value but e6ercisable only in the event of a potential takeover. "his tactic is effective in some cases. -2 3reenmail L when the shares held by a would8be ac%uiring firm are purchased at an amount substantially in e6cess of their fair value. "he shares are then usually held in treasury. "his tactic is generally ineffective. -# White knight or white s%uire L when a third firm more acceptable to the target company management is encouraged to ac%uire or merge with the target firm. -) :ac8man defense L when the target firm attempts an unfriendly takeover of the would8be ac%uiring company. -4 Selling the crown *ewels L when the target firms sells valuable assets to others to make the firm less attractive to an ac%uirer. 9. 'n an asset ac%uisition the firm must ac%uire 100E of the assets of the other firm while in a stock ac%uisition a firm may gain control by purchasing 40E or more of the voting stock. $lso in a stock ac%uisition formal negotiations with the target
+ull file at http==testbankinstant.&>="est8Bank8for8$dvanced8$ccounting84th8 dition8by8@eter 12.
a Ander the parent company concept noncontrolling interest is considered a liability of the consolidated entity whereas under the economic unit concept noncontrolling interest is considered a separate e%uity interest in consolidated net assets. b "he parent company concept supports partial elimination of intercompany profit whereas the economic unit concept supports 100 percent elimination of intercompany profit. c "he parent company concept supports valuation of subsidiary net assets in the consolidated financial statements at book value plus an amount e%ual to the parent company
1#. "he implied fair value based on the price may not be relevant or reliable since the price paid is a negotiated price which may be impacted by considerations other than or in addition to the f air value of the net assets of the ac%uired company. "here may be practical difficulties in determining the fair value of the consideration given and in allocating the total implied fair value to specific assets and liabilities.
'n the case of a less than wholly owned company valuation of net assets at implied fair value violates the cost principle of conventional accounting and results in the reporting of subsidiary assets and liabilities using a different valuation procedure than that used to report the assets and liabilities of the parent company. 1). "he economic entity is more consistent with the principles addressed in the +$SB
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181) Test Bank to accompany Jeter and Chaney Advanced Accounting
A'!.)R! T( B!I')!! )T2IC! CA!)
1. "he third item will lead to the reduction of net income of the ac%uired company before ac%uisition and will increase the reported net income of the combined company subse%uent to ac%uisition. "he accelerated payment of liabilities should not have an effect on net income in current or future years nor should the delaying of the collection of revenues -assuming those revenues have already been recorded. 2. "he first two items will decrease cash from operations prior to ac%uisition and will increase cash from operations subse%uent to ac%uisition. "he third item will not affect cash from operations. #. $s the manager of the ac%uired company ' would want to make it clear that my future performance -if ' stay on with the consolidated company should not be evaluated based upon a future decline that is perceived rather than real. +urther ' would e6press a concern that shareholders and other users might view such accounting maneuvers as sketchy. ). a arnings manipulation is unethical behavior no matter which side of the ac%uirer=ac%uiree e%uation you