Solution Manual: (Updated Through November 11, 2013)

Solution Manual
(Updated through November 11, 2013)
Chapter 2 - Introduction to Business Combinations and the

Consolidation Process
1. The Scope section of FASB ASC 805-10-15 specifically excludes joint ventures from the
provisions of the standard. As a result, joint ventures are not required to be consolidated
and should be accounted for using the equity method.
2. FASB ASC 805-10-65-1: The acquirers application of the recognition principle and
conditions may result in recognizing some assets and liabilities that the acquiree had not
previously recognized as assets and liabilities in its financial statements. For example, the
acquirer recognizes the acquired identifiable intangible assets, such as a brand name, a
patent, or a customer relationship, that the acquiree did not recognize as assets in its
financial statements because it developed them internally and charged the related costs to
expense.
3. FASB ASC 805-30-30-8 provides the following guidance relating to the transfer of assets
other than cash and stock: The consideration transferred may include assets or liabilities of
the acquirer that have carrying amounts that differ from their fair values at the acquisition
date (for example, nonmonetary assets or a business of the acquirer). If so, the acquirer
shall remeasure the transferred assets or liabilities to their fair values as of the acquisition
date and recognize the resulting gains or losses, if any, in earnings. However, sometimes the
transferred assets or liabilities remain within the combined entity after the business
combination (for example, because the assets or liabilities were transferred to the acquiree
rather than to its former owners), and the acquirer therefore retains control of them. In
that situation, the acquirer shall measure those assets and liabilities at their carrying
amounts immediately before the acquisition date and shall not recognize a gain or loss in
earnings on assets or liabilities it controls both before and after the business combination.
Bottom line if the asset will not remain with the consolidated group following the
acquisition, the acquirer can write up the asset before transfer and record the resulting gain
in income. And, if the asset remains with the consolidated entity post-acquisition, it cannot
be written up and no gain is recognized.
Cambridge Business Publishers, 2014

Solutions Manual, Chapter 2 2-1
4. FASB ASC 805-20-25-12 allows the acquirer to determine if the operating leases are
favorable or unfavorable compared with the market terms of similar leases at the
acquisition date. The acquirer shall recognize an intangible asset if the terms of an
operating lease are favorable relative to market terms and a liability if the terms are
unfavorable relative to market terms. FASB ASC 805-20-25-13 also provides for the
recognition of an intangible asset relating to operating leases, even if their terms are not
deemed to be favorable, if the leases provide entry into a market or other future economic
benefits that qualify as identifiable intangible assets, for example, as a customer
relationship.
5. FASB ASC 805-20-55-6 provides the following guidance: The acquirer subsumes into
goodwill the value of an acquired intangible asset that is not identifiable as of the
acquisition date. For example, an acquirer may attribute value to the existence of an
assembled workforce, which is an existing collection of employees that permits the acquirer
to continue to operate an acquired business from the acquisition date. An assembled
workforce does not represent the intellectual capital of the skilled workforcethe (often
specialized) knowledge and experience that employees of an acquiree bring to their jobs.
Because the assembled workforce is not an identifiable asset to be recognized separately
from goodwill, any value attributed to it is subsumed into goodwill.
6. FASB ASC 805-20-55-7 provides the following guidance: The acquirer also subsumes into
goodwill any value attributed to items that do not qualify as assets at the acquisition date.
For example, the acquirer might attribute value to potential contracts the acquiree is
negotiating with prospective new customers at the acquisition date. Because those
potential contracts are not themselves assets at the acquisition date, the acquirer does not
recognize them separately from goodwill.
7. FASB ASC 805-20-55-25 provides the following guidance: The agreement, whether
cancelable or not, meets the contractual-legal criterion. Additionally, because the Subsidiary
establishes its relationship with Customer through a contract, not only the agreement itself
but also the subsidiarys relationship with the Customer meets the contractual-legal
criterion.

2-2 Advanced Accounting by Halsey & Hopkins, 2nd Edition
8. FASB ASC 805-20-55-22 provides the following guidance: An order or production backlog
arises from contracts such as purchase or sales orders. An order or production backlog
acquired in a business combination meets the contractual-legal criterion even if the
purchase or sales orders are cancelable. Regardless of whether or not they are cancelable,
the purchase orders from 60 percent of the Subsidiarys customers meet the contractual-
legal criterion. Additionally, because the Subsidiary has established its relationship with 60
percent of its customers through contracts, not only the purchase orders but also the
Subsidiarys customer relationships meet the contractual-legal criterion. Because the
subsidiary has a practice of establishing contracts with the remaining 40 percent of its
customers, its relationship with those customers also arises through contractual rights and
therefore meets the contractual-legal criterion even though the Subsidiary does not have
contracts with those customers as of the acquisition date.
9. FASB ASC 805-20-55-23 provides the following guidance: If an entity establishes

relationships with its customers through contracts, those customer relationships arise from
contractual rights. Therefore, customer contracts and the related customer relationships
acquired in a business combination meet the contractual-legal criterion. Because the
Subsidiary establishes its relationships with policyholders through insurance contracts, the
customer relationship with policyholders meets the contractual-legal criterion, and can be
identified as an intangible asset in the acquisition.
10. FASB ASC 805-10-55-35 provides the following guidance (the acquired company is
referenced as the Target): In this Example, Target entered into the employment
agreement before the negotiations of the combination began, and the purpose of the
agreement was to obtain the services of the chief executive officer. Thus, there is no
evidence that the agreement was arranged primarily to provide benefits to Acquirer or the
combined entity. Therefore, the liability to pay $5 million is included in the application of
the acquisition method.
11. FASB ASC 805-10-55-36 provides the following guidance (the acquired company is
referenced as the Target): In other circumstances, Target might enter into a similar
agreement with the chief executive officer at the suggestion of Acquirer during the
negotiations for the business combination. If so, the primary purpose of the agreement
might be to provide severance pay to the chief executive officer, and the agreement may
primarily benefit Acquirer or the combined entity rather than Target or its former owners.
In that situation, Acquirer accounts for the liability to pay the chief executive officer in its
postcombination financial statements separately from application of the acquisition
method.

12. Yes, the investor has gained effective control of the investee company by virtue of its
control of the Board of Directors. Even though it owns less than 50% of the outstanding
voting stock, the license agreement gives it control of the investee company and, as a result,
the investee must be consolidated with the investor.
13. The acquisition should be accounted for as a business combination, thus requiring
consolidation. It is not necessary for the business to have outputs (i.e., products and sales).
FASB ASC 805-10-55-4 defines a business as follows: A business consists of inputs and
processes applied to those inputs that have the ability to create outputs. Although
businesses usually have outputs, outputs are not required for an integrated set to qualify as
a business.
14. a. Assets and liabilities can be valued using any reasonable approach. Some common
approaches to the tangible assets and liabilities in this example include the following:
Accounts receivable: Net realizable value (the amount we expect to collect)

Inventories: Estimated selling price less cost to complete (if work-in-
process) and less selling costs and a reasonable profit margin
on the sale. Raw materials are valued at replacement cost.
PPE: Current replacement costs if continued to be used in the
business or at selling price less cost to sell if to be sold.
Current liabilities: Book value
Long-term liabilities: Present value (i.e., discounted expected cash outflows)
b. Before any portion of the purchase price can be allocated to the Goodwill asset, you
must first ask if you are acquiring any intangible assets that are not recorded on the
acquirees balance sheet. A complete listing is in Exhibit 2.12. FASB ASC 805 requires us
to make a positive assessment whether any of these intangible assets were valued by us
in arriving at our purchase price for the acquiree and, if so, we must assign that value to
the intangible assets acquired before any of the purchase price can be assigned to the
Goodwill asset.
c. Intangible assets are typically valued at the present value of expected future cash flows.
We must, first, project the cash flows to be derived from the intangible asset. Then, we
need to discount those expected cash flows using an appropriate discount rate. This is a
very subjective process, as both the estimate of future cash flows and the choice of the
appropriate discount rate are difficult. We must make a reasonable attempt, however,
to value these intangible assets using a reasonable and supportable methodology.

15.
Intangible Asset Category Examples
Contract-based: lease agreements, franchise agreements, licensing
agreements, construction contracts, employment
contracts, and mineral rights
Marketing-related: brand names, trademarks, and Internet domain names
Customer-related: customer contracts, relationships, and orders
Technology-based: patent rights, computer software, and trade secrets
Artistic-based: television programs, motion pictures and videos,

recordings, books, photographs, and advertising jingles
16. An indemnification asset represents the agreement by the seller to guarantee that the
acquirer will not suffer a loss as a result of the outcome of a contingency related to all or
part of a specific asset or liability. For example, the seller may indemnify the purchaser
against losses above a specified amount on a liability arising from a particular contingency,
such as a pending lawsuit.
The acquirer recognizes an indemnification asset at the same time that it recognizes the
indemnified item (the contingent liability, for example). In addition, both the
indemnification asset and the related liability are revalued subsequent to the acquisition
(FASB ASC 805-20-25-27 through 25-28 and FASB ASC 805-20-35-4).
17. FAASB ASC 805-20-55-20 identifies a number of customer-related intangible assets,

including the following:
a. Customer lists - a customer list acquired in a business combination normally meets the
separability criterion.
b. Order backlog - an order or production backlog acquired in a business combination
meets the contractual-legal criterion even if the purchase or sales orders are cancelable.
c. Customer Relationship - If an entity has relationships with its customers through sales
orders, they meet the contractual-legal criterion. Customer relationships also may arise
through means other than contracts, such as through regular contact by sales or service
representatives.

18. a. Restructuring plans typically include the termination of employees as departments are
merged, the divestiture of lines of businesses with related plant closing costs, the
relocation and training of employees, and the write-off of assets such as Goodwill on the
acquirees balance sheet that relate to previous acquisitions that will no longer play a
part in the consolidated company.
b. FASB ASC 805-20-25-2 provides the following guidance relating to planned restructuring
activities: To qualify for recognition as part of applying the acquisition method, the
identifiable assets acquired and liabilities assumed must meet the definitions of assets
and liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements, at
the acquisition date. For example, costs the acquirer expects but is not obligated to
incur in the future to effect its plan to exit an activity of an acquiree or to terminate the
employment of or relocate an acquirees employees are not liabilities at the acquisition
date. Therefore, the acquirer does not recognize those costs as part of applying the
acquisition method. Instead, the acquirer recognizes those costs in its postcombination
financial statements in accordance with other applicable generally accepted accounting
principles (GAAP).
19. If financial statements are issued before the final allocations of the purchase can be made,
FASB ASC 805-10-55-16 allows us to use provisional amounts, that is, estimates of those
values. When the final allocation is made, we retrospectively adjust those amounts,
provided that the final measurement of all assets and liabilities is completed within one
year from the acquisition date. Also, during the measurement period, the acquirer can
recognize additional assets or liabilities if new information is obtained about facts and
circumstances that existed as of the acquisition date that, if known, would have resulted in
the recognition of those assets and liabilities as of that date.
20. A
a. No, a contingent liability for the employee litigation is not recognized at fair value on the
acquisition date because your attorney has determined that an unfavorable outcome is
reasonably possible, but not probable (ASC 450-20-25-2). Therefore, your company
would recognize a liability in the postcombination period when the recognition and
measurement criteria in ASC 450 are met.
b. The indemnification by the acquiree becomes an indemnification asset for the

purchaser and can be recognized as such on the consolidated balance sheet at the same
amount. Net assets acquired are, therefore, unaffected. Until the lawsuit is settled or
finally adjudicated, the contingent liability and the indemnification asset must both be
revalued at each balance sheet date and the change in value reflected in income (see
problem 16). Since the asset and liability are offsetting, however, their revaluation will
have offsetting amounts in the income statement, leaving net income unaffected.

21. A
a.
Equity investment 21,500,000
Common Stock 800,000
APIC 19,200,000
Contingent earnings liability 1,500,000
(to record the acquisition)
b.
Expense related to contingent earnings liability 500,000
Contingent earnings liability 500,000
(to record the increase in the expected value of the contingent earnings
liability)
c.
Expense related to contingent earnings liability 3,000,000
Contingent earnings liability 2,000,000
Cash 5,000,000
(to record the increase in the value of the contingent earnings
liability)
22. A
Purchase price $5,000,000
Less: Fair value of assets acquired 5,000,000
Deferred tax liability (350,000) 4,650,000 ($1 million x 35%)
Goodwill $350,000
23. Answer: d
A business is An integrated set of activities and assets that is capable of being conducted
and managed for the purpose of providing a return in the form of dividends, lower costs, or
other economic benefits directly to investors or other owners, members, or participants. It
is not necessary that the investee company currently produce products or generate a
positive return. All that is necessary is that it
a. has begun planned principal activities,
b. has employees, intellectual property, and other inputs and processes that could be
applied to those inputs,
c. is pursuing a plan to produce outputs, and
d. will be able to obtain access to customers that will purchase the outputs.

24. Answer: b
Company A has a controlling financial interest in both Companies B (90%) and C (90% x 70%
= 63%). Therefore B and C should be consolidated with A.
25. Answer: b
By holding 12,000 shares, former company B shareholders will own 55% (i.e., 12,000 /
(10,000 + 12,000) of the common stock after the transaction, suggesting they control the
company and can elect controlling Board within the next two years.
26. Answer: d
Direct fees have no effect on recording the business combination; these costs are simply
expensed as part of operating expenses for the period in which they are incurred. The entry
is as follows:
Expenses 200,000
Payables or cash (for direct acqu. costs) 200,000
Costs of registering and issuing securities are deducted from contributed capital; thus, they
have no effect on the investment account. The fair value of the common stock that is issued
(i.e., $5,000,000 = 500,000 shares x $10/share) will equal the amount of the net assets that
will be recognized in a business combination. The entry is as follows:
Investment in Investee 5,000,000

Common Stock ($2 par) 1,000,000
APIC 3,950,000
Payables or cash (for registration costs) 50,000
27. Answer: a
A controlling investment in an investee companys common stock is accounted for in an

equity investment account on the pre-consolidation books of the investor company. Thus,
there is no separate pre-consolidation recognition of goodwill. The process of consolidation
will eliminate the investment account and replace it with the fair value of the net assets of
the subsidiary in the post-consolidation financial statements.

28. Answer: b
The amount of goodwill implicit in an acquisition-date controlling investment in a subsidiary

is equal to the fair value of the entire subsidiary (i.e., $1,100,000) minus the fair value of the
identifiable net assets (FVINA). According to the facts, the book value of the identifiable net
assets is equal to $800,000. The only identifiable difference between fair value and book
value is $220,000 related to property and equipment. Thus, the FVINA is equal to
$1,020,000 (i.e., $800,000 + $220,000). Therefore, goodwill is equal to $80,000 (i.e.,
$1,100,000 - $1,020,000).
29. Answer: d
In the case where (1) the fair value of the identifiable net assets of a subsidiary equals the
book value of identifiable net assets of the subsidiary, and there is no recorded goodwill or
bargain acquisition gain, then the investment account will equal the book value of net
assets of the subsidiary (i.e., which also equals the stockholders equity of the subsidiary).
Net assets equals $170,000 (i.e., CS, $10,000 + APIC, $150,000 + RE, $10,000).
30. Answer: d
In the absence of profits (losses) on intercompany transactions, the investment account at

any point in time can be computed by taking p% of the book value of net assets (BVNA) of
the subsidiary and adding the unamortized p% acquisition accounting premium (AAP). In
this problem, p% = 100%. On the acquisition date, the unamortized AAP is equal to the
following (note that the amounts are expressed in debits and credits):
AAP
Dr (Cr)
Receivables & Inventories 10,000
Land (5,000)
Property & Equipment 20,000
Goodwill 25,000
Liabilities 7,000
Total AAP 57,000
100% BVNA(S) + 100% AAP = $170,000 + $57,000 = $227,000

31. Answer: b
Consolidated financial statements must be prepared by a company that has a controlling

financial interest in other entities. In this case, Sun also prepares stand-alone financial
statements (perhaps for a bank or other creditor). There is no evidence that Sun has a
controlling financial interest in another entity.
32. Answer: b
Assuming no intercompany payables/receivables, on the acquisition date, there are only

two consolidating journal entries required: [E] and [A]. The [E] entry eliminates the book
value of net assets of the subsidiary (i.e., which equals reported stockholders equity) form
the investment account. Stockholders equity of S equals $562,500 (i.e., CS $125,000 + APIC
$156,250 + RE $281,250). This means the [A] credit to the investment account must have
been $312,500 (i.e., $875,000 - $562,500).
33. A Answer: c
Generally speaking, in a nontaxable transaction, the pre-acquisition tax bases of the

subsidiarys net assets carry forward to the post-acquisition tax books. This can result in
deferred taxes if the recognized fair values have temporary differences from the carried
forward tax bases. In this case, the only asset that has a different tax basis from its newly
recognized fair value is noncurrent assets with a fair value that is $20,000 greater than its
previous book value and tax basis. The deferred tax liability on this $20,000 temporary
difference is $8,000 (i.e., 40% x $20,000). Therefore, including the deferred tax, the fair
value of the identifiable net assets (FVINA) for the subsidiary is equal to $112,000 (i.e.,
BVINA $100,000 + noncurrent asset AAP $20,000 deferred tax liability AAP $8,000).
Goodwill is equal to the fair value of the entire subsidiary minus the FVINA, which equals
$38,000 (i.e., FV subsidiary $150,000 FVINA $112,000).
34. A Answer: b
Generally speaking, in a taxable transaction, the post-acquisition tax bases of the

subsidiarys net assets are equal to the fair value of the net assets of the subsidiary. Given
no difference in financial versus tax bases, this means that there are no deferred taxes
recognized pursuant to the acquisition. In this problem, the only asset that has a different
tax basis from its newly recognized fair value is noncurrent assets with a fair value that is
$20,000 greater than its previous book value and tax basis. Therefore, the fair value of the
identifiable net assets (FVINA) for the subsidiary is equal to $120,000 (i.e., BVINA $100,000
+ noncurrent asset AAP $20,000). Goodwill is equal to the fair value of the entire subsidiary
minus the FVINA, which equals $30,000 (i.e., FV subsidiary $150,000 FVINA $120,000).

35. Fair value of total assets acquired (excluding goodwill) $49,973
Plus: Goodwill ?
Less: Fair value of total liabilities assumed $25,353
= Total consideration transferred $24,659
Goodwill = $39
36. a. Goodwill = $20 million - $7 million - $6 million - $5 million = $2 million. The acquisition
costs are expensed under GAAP (SFAS 141(R), 59).
b. Goodwill is not amortized like other intangible assets. Instead, it remains on the balance
sheet until management deems it to be impaired, at which time it is written down.
c. Allocating more of the purchase price to goodwill reduces the allocation to assets that
are depreciated or amortized and, therefore, reduces the depreciation and/or
amortization expense hitting their income statements subsequent to the acquisition.
37. a. The amounts relating to working capital, inventories and PPE assets are the fair values
of those assets on the acquisition date. These amounts reflect the book values of those
assets on Wyeths balance sheet plus the AAP, the difference between fair value and
book value. These are the amounts that will appear on the consolidated balance sheet
relating to Wyeth, and the reported amounts will be the sum of these values plus the
book value of these assets on Pfizers balance sheet on the acquisition date.
b. In-process research and development (IPRD) assets relate to the acquisition-date value
of research projects currently in process and during their developmental stages (i.e.,
before the research projects have reached technological feasibility). Under current
GAAP, investors value and recognize IPRD assets acquired in a business combination at
their fair values just like any other assets acquired (FASB ASC 350-30-30-1. After initial
recognition, tangible net assets used to support research and development activities
(e.g., R&D building and associated equipment) are accounted for in accordance with
their nature (i.e., they are depreciated/amortized). Intangible research and
development assets, on the other hand, should be considered indefinite-lived (i.e., not
amortized) until the associated research and development activities are either
completed (then, the intangible assets are amortized over the life of the related patent
or copyright) or abandoned (in which case they are written off in the year of
abandonment). Acquired intangible IPRD assets are included in the annual goodwill
impairment tests (FASB ASC 350-20-35-15).
c. The value assigned to Goodwill is not computed directly. Instead, it is computed as a

residual amount (i.e., the amount left over after all other assets and liabilities have been
identified and valued).

38. a. The arguments in favor of Company A as the acquirer are the following:
i. It issued the stock.
ii. Its CEO will become CEO of the combined company.
The arguments in favor of Company B as the acquirer are the following:

i. Its Chairman will become Chairmen of the combined company.
ii. Its CFO will become CFO of the combined company.
On balance, it would appear that Company A is the acquirer. Its CEO will be the chief
executive of the combined entity, and, in three years, Company As Chairman will
become the new Company Chairman as well. During the interim, neither company can
control the strategic direction of the combined company since each elects one-half of the
Board of Directors.
b. The allocation of the purchase price is quite different for the two potential acquirers:
If Company A If Company B
is deemed to be is deemed to be
the Subsidiary the Subsidiary
Purchase Price $ 1.5 billion $ 1.5 billion
Tangible net assets (1.0 billion) (0.4 billion)
Identifiable intangible assets (0.3 billion) (0.6 billion)
Goodwill $ 0.2 billion $ 0.5 billion
If Company B is the acquirer and Company A is the subsidiary, more of the purchase
price will be allocated to the fair value of tangible net assets and identifiable intangible
assets. Both of these categories must be depreciated or amortized. As a result, more of
the purchase cost will hit the consolidated income statement (Goodwill is not
amortized, and becomes an expense only if impaired). Also, if Company B is the
acquirer, less Goodwill asset will be recognized. The choice of the acquirer is often not
an issue. But, when it is, it can be a significant one.
This analysis is made solely from a financial perspective. There are other significant
implications of the choice of the acquirer, including
The acquirer may get to name the combined company with its name or using its
name first.
The image of the combined company in the market place may be different
depending on which company is viewed as the acquirer.
The acquirers philosophies and modes of operation may dominate the combined
company.
The acquirer may get the choice of the home office.
The acquirers employees may feel a sense of superiority. Conversely, the
acquirees employees may feel like theyve been taken over. This can cause real
morale problems if not handled well.

39. a.
Equity investment 100,000
Common stock 10,000
Additional paid-in capital 90,000
b.
[E] Common stock 30,000
Retained earnings 45,000
(to eliminate the Stockholders Equity of the subsidiary on
the acquisition date)
[A] PPE (net) 25,000

Equity Investment 25,000
(to record the [A] assets purchased on the acquisition
date)
40. a.
Cash 250,000
b.
(to eliminate the Stockholders Equity of the subsidiary on
the acquisition date)
[A] Patent 100,000

Goodwill 50,000
date)

41. a. Balance of Equity Investment account:
Purchase price $300,000

Cumulative net income of subsidiary 400,000
Cumulative dividends received from subsidiary (50,000)
Balance of Equity Investment account $650,000
b. The Equity Investment account is comprised of the fair values of the net assets of the
subsidiary ($550,000, which happen to equal the book values) and the carrying amount
of the Goodwill asset ($100,000).
42. a.
[E] Capital stock and Retained earnings 8,795
(to eliminate the stockholders equity of the subsidiary on the
acquisition date)
[A] Inventory 2,979

Long-term Investments 40
PPE (net) 439
In-process R&D charge 5,052
Identifiable intangible assets 37,221
Goodwill ($20,447-$1,559) 18,888
Long-term debt 370
Benefit plan liabilities 1,471
Other net assets 431
Restructuring costs 1,578
Tax adjustments 13,592
(to record the [A] assets purchased on the acquisition date)
b. In-Process Research & Development (IPRD) is expensed in the [A] entry in part (a) as
required under previous GAAP. Under current GAAP, acquirers recognize IPRD assets
acquired in a business combination at their fair values just like any other assets acquired
(FASB ASC 350-30-30-1). After initial recognition, tangible net assets used to support
research and development activities (e.g., R&D building and associated equipment) are
accounted for in accordance with their nature (i.e., they are depreciated/amortized).
Intangible research and development assets, on the other hand, should be considered
indefinite-lived (i.e., not amortized) until the associated research and development
activities are either completed (then, the intangible assets are amortized over the life of
the related patent or copyright) or abandoned (in which case they are written off in the
year of abandonment). Acquired intangible IPRD assets are included in the annual
Goodwill impairment tests (FASB ASC 350-20-35-15).

c. Pfizer accrued a liability for its anticipated restructuring costs in its allocation of the
Pharmacia purchase price. That was acceptable practice under former GAAP. FASB ASC
805-20-25-2 provides the guidance relating to planned restructuring activities that is
currently in effect: costs the investor expects but is not obligated to incur in the future
to affect its plan to exit an activity of an investee or to terminate the employment of or
relocate an investees employees are not liabilities at the acquisition date. Therefore,
the investor does not recognize those costs as part of applying the acquisition method.
Instead, the investor recognizes those costs in its post-combination financial statements
in accordance with other applicable generally accepted accounting principles. As a
result, under current GAAP, acquisition-date Goodwill would have been smaller by the
amount of the restructuring charge, as compared to pre-2008 GAAP.
43. a. No, this is the fair value of these assets. The [A] consolidation journal entry records the
difference between the fair value and the book value of these assets on the acquirees
acquisition-date balance sheet.
b.
[A] Customer contracts 1,942
Technology 1,501
Trademarks 74
Trade name 1,422
Goodwill 14,450
(to record the intangible assets)
c. Amortizable intangible assets have a useful life and must be amortized over that useful
life. The cost of these assets is ultimately reflected as expense in the income statement.
To the extent that this portion of the purchase price is allocated to Goodwill, that cost
does not impact the income statement unless and until the Goodwill asset is deemed to
be impaired, at which time it is written down or off. SFAS 141(R) requires companies to,
first, allocate the purchase price to identifiable intangible assets before recognizing any
goodwill in the purchase.
d. HP does not feel that the Compaq trade name will be diminished in value over time, that
is, it will continue to generate cash flows indefinitely. Indefinite does not mean infinite.
The accounting significance of this distinction is that indefinite-lived assets must be
tested at least annually for impairment.

44. a.
Approach Methodology Asset Class
Market Indicates value for a subject asset Real property and investments
approach based on available market pricing for
comparable assets
Income Indicates value for a subject asset Certain intangible assets such as
approach based on the present value of cash customer relationships, as well
flow projected to be generated by the as for favorable/unfavorable
asset contracts
Cost approach Estimates value by determining the The majority of personal

current cost of replacing an asset with property
another of equivalent economic utility
b. The market approach (using comparable market prices for similar assets) and the cost
approach (using replacement cost) are the least subjective approaches. The income
approach (sometimes referred to as discounted cash flow or DCF approach) is the most
subjective approach as it involves both the projection of cash flows and the choice of an
appropriate discount rate. In its allocation of the purchase price for MCI to the assets
acquired and the liabilities assumed, a significant portion of the purchase price was
allocated to intangible assets using the income approach. This is not uncommon.
Remember this next time you look at a purchase price allocation table.
c. The allocation of the purchase price to net tangible and intangible assets is as follows:
Current assets $ 6,001

PPE 6,453
Deferred income tax & other assets 1,995
Current liabilities (6,093)
Long-term Debt (6,169)
Deferred income taxes & other liabilities (1,720)
Net tangible assets $ 467 (7%)
Intangible assets subject to amortization:

Customer relationships $ 1,162
Right of way and other 176
Goodwill 5,085
Intangible assets $ 6,423 (93%)
Total Purchase price $ 6,890

45. a. 40,000 shares x $25 market price per share = $1,000,000
b.
APIC 125,000
(to eliminate the stockholders equity of the subsidiary
on the acquisition date)
c.
Elimination entries
Parent Subsidiary Dr Cr Consolidated
Balance sheet:
Assets
Cash $ 405,000 $ 226,000 $ 631,000
Accounts receivable 1,280,000 348,000 1,628,000
Inventory 1,940,000 447,000 2,387,000
Equity investment 1,000,000 [E] 1,000,000 0
PPE, net 9,332,000 827,000 10,159,000
$13,957,000 $1,848,000 $14,805,000
Liabilities and Stockholders Equity

Accounts payable $ 627,000 $ 127,000 $ 754,000
Accrued liabilities 736,000 221,000 957,000
Long-term liabilities 3,000,000 500,000 3,500,000
Common stock 1,370,000 100,000 [E] 100,000 1,370,000
APIC 3,200,000 125,000 [E] 125,000 3,200,000
Retained earnings 5,024,000 775,000 [E] 775,000 5,024,000
$13,957,000 $1,848,000 $14,805,000

46. a. 70,000 shares x $25 market price per share = $1,750,000
b.
APIC 125,000
(to eliminate the Stockholders Equity of the subsidiary
on the acquisition date)
[A] Patent 200,000

Goodwill 550,000
date)
c.
Elimination entries
Balance sheet:
Assets
Cash $ 3,082,500 $ 226,000 $ 3,308,500
Accounts receivable 1,280,000 348,000 1,628,000
Inventory 1,940,000 447,000 2,387,000
[A] 750,000
PPE, net 9,332,000 827,000 10,159,000
Patent [A] 200,000 200,000
Goodwill [A] 550,000 550,000
$17,384,500 $1,848,000 $18,232,500

Common stock 2,397,500 100,000 [E] 100,000 2,397,500
APIC 5,600,000 125,000 [E] 125,000 5,600,000
$17,384,500 $1,848,000 $18,232,500
d. We have recognized the Patent and Goodwill assets. Previously, these assets were
embedded in the Equity Investment account on the Parents balance sheet. In the
consolidation process, they are explicitly recognized.

47. a. The following acquisition date consolidated balance sheet can be used to answer
questions a1-a7.
Elimination entries
Balance sheet:
Assets
Cash $ 910,500 $ 201,600 $1,112,100
Accounts receivable 384,000 417,600 801,600
Inventory 582,000 536,400 1,118,400
[A] 1,000,000
PPE, net 2,799,600 992,400 [A] 500,000 4,292,000
License agreement [A] 250,000 250,000
Customer list [A] 100,000 100,000
Goodwill [A] 150,000 150,000
$6,876,100 $2,148,000 $7,824,100

Common stock 220,000 120,000 [E] 120,000 220,000
APIC 3,740,000 150,000 [E] 150,000 3,740,000
$6,876,100 $2,148,000 $7,824,100
b. We will report the License Agreement ($250,000), Customer List ($100,000), and
Goodwill ($150,000).
48. a.
Common stock 70,000
APIC 2,030,000
continued next page

b.
APIC 162,500
Retained earnings 1,007,500
(to eliminate the stockholders equity of the subsidiary
as of the acquisition date)
[A] Trademark 200,000
Video library 500,000
Patented technology 100,000
(to record the Trademark, Video Library, and Patented
Technology {a} assets)
c.
Elimination entries
Balance sheet:
Assets
Cash $ 428,200 $ 189,400 $ 617,600
Accounts receivable 256,000 452,400 708,400
Inventory 388,000 581,100 969,100
[A] 800,000
PPE, net 9,666,400 1,075,100 10,741,500
Trademark [A] 200,000 200,000
Video library [A] 500,000 500,000
Patented technology [A] 100,000 100,000
$12,838,600 $2,298,000 $13,836,600

Common stock 357,000 130,000 [E] 130,000 357,000
APIC 2,730,000 162,500 [E] 162,500 2,730,000
Retained earnings 6,279,000 1,007,500 [E] 1,007,500 6,279,000
$12,838,600 $2,298,000 $13,836,600
d. We have recognized three intangible assets in the consolidation process: the Trademark,
the Video Library, and Patented Technology. Previously, these assets were embedded in
the Equity investment account on the Parents balance sheet. In the consolidation
process, they are explicitly recognized.

49. a.
Common stock 120,000
APIC 3,480,000
Contingent consideration liability 400,000
(to record the Equity investment, issuance of shares, and
contingent consideration liability)
b.
Elimination entries
Balance sheet:
Assets
Cash $ 783,300 $ 104,000 $ 887,300
Accounts receivable 384,000 696,000 1,080,000
Inventory 582,000 894,000 1,476,000
[A] 2,000,000
PPE, net 14,499,600 1,654,000 [A] 1,000,000 17,153,600
Customer list [A] 200,000 200,000
Brand name [A] 500,000 500,000
Goodwill [A] 895,000 895,000
$20,248,900 $3,348,000 $22,191,900

Long-term liabilities 2,000,000 1,000,000 3,000,000
Deferred tax liab. [A] 595,000 595,000
Common stock 680,000 200,000 [E] 200,000 680,000
APIC 5,200,000 250,000 [E] 250,000 5,200,000
Retained earnings $11,960,000 1,550,000 [E] 1,550,000 11,960,000
20,248,900 $3,348,000 $22,191,900
Notes:
1. The contingent consideration liability is reported on the Parents balance sheet on
the date of acquisition. In subsequent periods, and until paid or discharged, that
liability must be revalued and any change in fair value reflected in income.
2. A deferred tax liability of $595,000 is established for the book-tax difference of $1
million related to the PPE assets, $200,000 for the customer list, and $500,000 for
the brand name asset (i.e., $1,700,000 total book-tax difference) multiplied by the
tax rate of 35%.
continued next page

b. continued
Notes continued:
3. Goodwill is computed as follows:
Value of consideration
(stock plus contingent consideration) $4,000,000
Less:
Fair value of net assets $3,700,000
Deferred income tax liability (595,000) 3,105,000
Goodwill $ 895,000
50. a. FASB ASC 805-10-25-13 through 25-19 permits companies to use provisional amounts,
and to retrospectively adjust those amounts when better information becomes
available, provided that the final measurement of all assets and liabilities is completed
within one year from the acquisition date.
b. In $millions
Cash 7,196
Common stock and APIC 99
c. The value assigned to Goodwill is not computed directly. Instead, it is computed as a

residual amount (i.e., the amount left over after all other assets and liabilities have been
identified and valued).
d. FASB ASC 805-20-30-1 requires that, as of the acquisition date, The acquirer shall
measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling
interest in the acquiree at their acquisition-date fair values, and FASB ASC 820-10-20
defines fair value as the price that would be received to sell an asset or paid to transfer
a liability in an orderly transaction between market participants at the measurement
date. Companies can estimate these fair values using a market approach, an income
approach, or a cost approach. Each of these approaches requires significant
estimates.
e. In-process research and development (IPRD) assets relate to the value of research
projects currently in process and during their developmental states (i.e., before the
research projects have reached technological feasibility) on the date of the acquisition.
These might include, for example, patents received or applied for, blueprints, formulas,
and specifications or designs for new products or processes, materials and supplies,
equipment and facilities, and perhaps even a specific research project in process.
continued next page

e. continued
Under current GAAP, acquirers recognize IPRD assets acquired in a business combination
at their fair values just like any other assets acquired (FASB ASC 350-30-30-1). After initial
recognition, tangible net assets used to support research and development activities
(e.g., R&D building and associated equipment) are accounted for in accordance with their
nature (i.e., they are depreciated/amortized). Intangible research and development
assets, on the other hand, should be considered indefinite-lived (i.e., not amortized) until
the associated research and development activities are either completed (then, the
intangible assets are amortized over the life of the related patent or copyright) or
abandoned (in which case they are written off in the year of abandonment). Acquired
intangible IPRD assets are included in the annual goodwill impairment tests (FASB ASC
350-20-35-15).
f. If the acquisition-date fair value of the asset or liability arising from a contingency can be
determined during the measurement period, that asset or liability is recognized at the
acquisition date (FASB ASC 805-20-25-19).
g. Oracle credits the Equity Investment account for its book value of $7,295 million to
remove that account from the consolidated balance sheet. The offsetting debits and
credits will remove the beginning-of-year stockholders equity of Sun Microsystems, Inc.,
and recognizes, as reported assets and liabilities on the consolidated balance sheet, the
excess of the fair value of the acquired assets and liabilities assumed in excess of their
respective books values.


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Solution Manual

(Updated through November 11, 2013)

Chapter 2 - Introduction to Business Combinations and the

Cambridge Business Publishers, 2014

Cambridge Business Publishers, 2014

9. FASB ASC 805-20-55-23 provides the following guidance: If an entity establishes

Cambridge Business Publishers, 2014

Accounts receivable: Net realizable value (the amount we expect to collect)

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Marketing-related: brand names, trademarks, and Internet domain names

Customer-related: customer contracts, relationships, and orders

Technology-based: patent rights, computer software, and trade secrets

Artistic-based: television programs, motion pictures and videos,

17. FAASB ASC 805-20-55-20 identifies a number of customer-related intangible assets,

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b. The indemnification by the acquiree becomes an indemnification asset for the

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Cambridge Business Publishers, 2014

Investment in Investee 5,000,000

A controlling investment in an investee companys common stock is accounted for in an

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The amount of goodwill implicit in an acquisition-date controlling investment in a subsidiary

In the absence of profits (losses) on intercompany transactions, the investment account at

100% BVNA(S) + 100% AAP = $170,000 + $57,000 = $227,000

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Consolidated financial statements must be prepared by a company that has a controlling

Assuming no intercompany payables/receivables, on the acquisition date, there are only

Generally speaking, in a nontaxable transaction, the pre-acquisition tax bases of the

Generally speaking, in a taxable transaction, the post-acquisition tax bases of the

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c. The value assigned to Goodwill is not computed directly. Instead, it is computed as a

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The arguments in favor of Company B as the acquirer are the following:

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[A] PPE (net) 25,000

[A] Patent 100,000

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Purchase price $300,000

[A] Inventory 2,979

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Cost approach Estimates value by determining the The majority of personal

Current assets $ 6,001

Intangible assets subject to amortization:

Total Purchase price $ 6,890

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Liabilities and Stockholders Equity

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[A] Patent 200,000

Liabilities and Stockholders Equity

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Liabilities and Stockholders Equity

continued next page

Cambridge Business Publishers, 2014

Liabilities and Stockholders Equity

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Liabilities and Stockholders Equity

continued next page

Cambridge Business Publishers, 2014

c. The value assigned to Goodwill is not computed directly. Instead, it is computed as a

continued next page

Cambridge Business Publishers, 2014

Cambridge Business Publishers, 2014