Chapter 01—Business Combinations: New Rules for a Long-Standing Business Practice
Multiple Choice
1. An economic advantage of a business combination includes:
a. Utilizing duplicative assets.
b. Creating separate management teams.
c. Shared fixed costs.
d. Horizontally combining levels within the marketing chain.
ANSWER: c
RATIONALE: Business combinations may viewed as a way to take advantage of economies of scale by
utilizing common facilities and sharing fixed costs.
DIFFICULTY: E
LEARNING OBJECTIVES: ADAC.FISC.1-1
2. One large bank’s acquisition of another bank would be an example of a:
a. market extension merger.
b. conglomerate merger.
c. product extension merger.
d. horizontal merger.
ANSWER: d
RATIONALE: A horizontal merger occurs when two companies offering similar products or services that
are likely competitors in the same marketplace merge.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.1-1
3. A large nation-wide bank’s acquisition of a major investment advisory firm would be an example of a:
a. market extension merger.
b. conglomerate merger.
c. product extension merger.
d. horizontal merger.
ANSWER: c
RATIONALE: A product extension merger occurs when the acquiring company is expanding its product
offerings in the market place in which it sells.
DIFFICULTY: M
LEARNING OBJECTIVES: OBJ: ADAC.FISC.1-1
4. A building materials company’s acquisition of a television station would be an example of a:
a. market extension merger.
b. conglomerate merger.
c. product extension merger.
d. horizontal merger.
ANSWER: b
RATIONALE: Because these firms are in unrelated lines of business, this would be a conglomerate merger.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.1-1
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,Chapter 01—Business Combinations: New Rules for a Long-Standing Business Practice
5. A tax advantage of business combination can occur when the existing owner of a company sells out and receives:
a. cash to defer the taxable gain as a "tax-free reorganization."
b. stock to defer the taxable gain as a "tax-free reorganization."
c. cash to create a taxable gain.
d. stock to create a taxable gain.
ANSWER: b
RATIONALE: If the owners of a business sell their interests for cash or accept debt instruments, they would
have an immediate taxable gain. However, if they accept common stock of another
corporation and the transaction is crafted as such, they may account for the transaction as a
“tax-free reorganization.” If this is the case, no taxes are paid until they sell the shares
received in the transaction.
DIFFICULTY: E
LEARNING OBJECTIVES: ADAC.FISC.1-1
6. A controlling interest in a company implies that the parent company
a. owns all of the subsidiary's stock.
b. has acquired a majority of the subsidiary's common stock.
c. has paid cash for a majority of the subsidiary's stock.
d. has transferred common stock for a majority of the subsidiary's outstanding bonds and debentures.
ANSWER: b
RATIONALE: Typically, a controlling interest is over 50% of the company’s voting stock.
DIFFICULTY: E
LEARNING OBJECTIVES: ADAC.FISC.1-2
7. Some advantages of obtaining control by acquiring a controlling interest in stock include all but:
a. Negotiations are made directly with the acquiree’s management.
b. The legal liability of each corporation is limited to its own assets.
c. The cost may be lower since only a controlling interest in the assets, not the total assets, is acquired.
d. Tax advantages may result from preservation of the legal entities.
ANSWER: a
RATIONALE: If a company was acquiring a controlling interest in stock, the negotiations would be with the
target company’s stockholders.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.1-2
8. A(n) ________________ occurs when the management of the target company purchases a controlling interest in that
company and the company incurs a significant amount of debt as a result.
a. greenmail
b. statutory merger
c. poison pill
d. leveraged buyout
ANSWER: d
RATIONALE: A leveraged buyout is defensive move against an unfriendly takeover where management of
the target company purchases a controlling interest in the company. Usually, a significant
amount of debt is incurred.
DIFFICULTY: E
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,Chapter 01—Business Combinations: New Rules for a Long-Standing Business Practice
LEARNING OBJECTIVES: ADAC.FISC.1-2
9. Acquisition costs such as the fees of accountants and lawyers that were necessary to negotiate and consummate the
purchase are
a. recorded as a deferred asset and amortized over a period not to exceed 15 years
b. expensed if immaterial but capitalized and amortized if over 2% of the acquisition price
c. expensed in the period of the purchase
d. included as part of the price paid for the company purchased
ANSWER: c
RATIONALE: Direct costs of the acquisition, such as professional fees incurred to negotiate and
consummate the purchase, are expensed in the period of purchase. Costs related to the
issuance of securities related to the purchase may be deducted from the value assigned to
paid-in capital in excess of par.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.1-3
10. Which of the following costs of a business combination can be deducted from the value assigned to paid-in capital in
excess of par?
a. Direct and indirect acquisition costs.
b. Direct acquisition costs.
c. Direct acquisition costs and stock issue costs if stock is issued as consideration.
d. Stock issue costs if stock is issued as consideration.
ANSWER: d
RATIONALE: Stock issue costs can be deducted from the value assigned to paid-in capital in excess of par
when stock is issued as consideration. All other direct and indirect acquisition costs are
expensed.
DIFFICULTY: E
LEARNING OBJECTIVES: ADAC.FISC.1-3
11. When determining the fair values of assets acquired in an acquisition, the highest level of measurement per GAAP is
a. adjusted market value based on prices of similar assets.
b. unadjusted market values in an actively traded market.
c. based on discounted cash flows.
d. the entity’s best estimate of an exit or sale value.
ANSWER: b
RATIONALE: FASB provides a hierarchy of values where the highest level measurement possible should be
used. The levels are as follows:
Level 1 - Unadjusted quoted market values in an actively traded market.
Level 2 - Adjusted market value based on prices of similar assets or on observable other
inputs such as interest rates.
Level 3 - Fair value based on unobservable inputs such as the entity’s best estimate of an exit
value.
DIFFICULTY: E
LEARNING OBJECTIVES: ADAC.FISC.1-3
12. Larry’s Liquor acquired the net assets of Drake’s Drinks in exchange for cash. The acquisition price exceeds the fair
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, Chapter 01—Business Combinations: New Rules for a Long-Standing Business Practice
value of the net assets acquired. How should Larry’s Liquor determine the amounts to be reported for the plant and
equipment, and for long-term debt of the acquired Drake’s Drinks?
Plant and Equipment Long-Term Debt
a. Fair value Drake's carrying amount
b. Fair value Fair value
c. Drake's carrying amount Fair value
d. Drake's carrying amount Drake's carrying amount
ANSWER: b
RATIONALE: All assets acquired and liabilities assumed in an acquisition should be recorded at fair value.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.1-4
13. Crystal Co. purchased all of the common stock of Sill Corp. on January 1 of the current year. Five years prior to the
acquisition, Sill Corp. had issued 30-year bonds bearing an interest rate of 8%. At the time of the acquisition, the
prevailing interest rate for similar bonds was 5%. These bonds should be included in the consolidated balance sheet at
a. face value.
b. at a value higher than Sill’s recorded value due to the change in interest rates.
c. at a value lower than Sill’s recorded value due to the change in interest rates.
d. at Sill’s recorded value.
ANSWER: b
RATIONALE: All assets acquired and liabilities assumed should be recorded at their fair values. A change
in interest rates may result in a market value that is different than the recorded value of the
bonds. Generally, when interest rates fall, prices on bonds with higher stated interest rates
will increase as investors are generally willing to pay more for the higher rate of return.
DIFFICULTY: D
LEARNING OBJECTIVES: ADAC.FISC.1-4
14. ACME Co. paid $110,000 for the net assets of Comb Corp. At the time of the acquisition the following information
was available related to Comb's balance sheet:
Book Value Fair Value
Current Assets $50,000 $ 50,000
Building 80,000 100,000
Equipment 40,000 50,000
Liabilities 30,000 30,000
What is the amount recorded by ACME for the Building?
a. $110,000
b. $20,000
c. $80,000
d. $100,000
ANSWER: d
RATIONALE: Identifiable assets and liabilities of the acquiree are recorded at fair value.
DIFFICULTY: E
LEARNING OBJECTIVES: ADAC.FISC.1-4
15. ABC Co. is acquiring XYZ Inc. XYZ has the following intangible assets:
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Multiple Choice
1. An economic advantage of a business combination includes:
a. Utilizing duplicative assets.
b. Creating separate management teams.
c. Shared fixed costs.
d. Horizontally combining levels within the marketing chain.
ANSWER: c
RATIONALE: Business combinations may viewed as a way to take advantage of economies of scale by
utilizing common facilities and sharing fixed costs.
DIFFICULTY: E
LEARNING OBJECTIVES: ADAC.FISC.1-1
2. One large bank’s acquisition of another bank would be an example of a:
a. market extension merger.
b. conglomerate merger.
c. product extension merger.
d. horizontal merger.
ANSWER: d
RATIONALE: A horizontal merger occurs when two companies offering similar products or services that
are likely competitors in the same marketplace merge.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.1-1
3. A large nation-wide bank’s acquisition of a major investment advisory firm would be an example of a:
a. market extension merger.
b. conglomerate merger.
c. product extension merger.
d. horizontal merger.
ANSWER: c
RATIONALE: A product extension merger occurs when the acquiring company is expanding its product
offerings in the market place in which it sells.
DIFFICULTY: M
LEARNING OBJECTIVES: OBJ: ADAC.FISC.1-1
4. A building materials company’s acquisition of a television station would be an example of a:
a. market extension merger.
b. conglomerate merger.
c. product extension merger.
d. horizontal merger.
ANSWER: b
RATIONALE: Because these firms are in unrelated lines of business, this would be a conglomerate merger.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.1-1
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,Chapter 01—Business Combinations: New Rules for a Long-Standing Business Practice
5. A tax advantage of business combination can occur when the existing owner of a company sells out and receives:
a. cash to defer the taxable gain as a "tax-free reorganization."
b. stock to defer the taxable gain as a "tax-free reorganization."
c. cash to create a taxable gain.
d. stock to create a taxable gain.
ANSWER: b
RATIONALE: If the owners of a business sell their interests for cash or accept debt instruments, they would
have an immediate taxable gain. However, if they accept common stock of another
corporation and the transaction is crafted as such, they may account for the transaction as a
“tax-free reorganization.” If this is the case, no taxes are paid until they sell the shares
received in the transaction.
DIFFICULTY: E
LEARNING OBJECTIVES: ADAC.FISC.1-1
6. A controlling interest in a company implies that the parent company
a. owns all of the subsidiary's stock.
b. has acquired a majority of the subsidiary's common stock.
c. has paid cash for a majority of the subsidiary's stock.
d. has transferred common stock for a majority of the subsidiary's outstanding bonds and debentures.
ANSWER: b
RATIONALE: Typically, a controlling interest is over 50% of the company’s voting stock.
DIFFICULTY: E
LEARNING OBJECTIVES: ADAC.FISC.1-2
7. Some advantages of obtaining control by acquiring a controlling interest in stock include all but:
a. Negotiations are made directly with the acquiree’s management.
b. The legal liability of each corporation is limited to its own assets.
c. The cost may be lower since only a controlling interest in the assets, not the total assets, is acquired.
d. Tax advantages may result from preservation of the legal entities.
ANSWER: a
RATIONALE: If a company was acquiring a controlling interest in stock, the negotiations would be with the
target company’s stockholders.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.1-2
8. A(n) ________________ occurs when the management of the target company purchases a controlling interest in that
company and the company incurs a significant amount of debt as a result.
a. greenmail
b. statutory merger
c. poison pill
d. leveraged buyout
ANSWER: d
RATIONALE: A leveraged buyout is defensive move against an unfriendly takeover where management of
the target company purchases a controlling interest in the company. Usually, a significant
amount of debt is incurred.
DIFFICULTY: E
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,Chapter 01—Business Combinations: New Rules for a Long-Standing Business Practice
LEARNING OBJECTIVES: ADAC.FISC.1-2
9. Acquisition costs such as the fees of accountants and lawyers that were necessary to negotiate and consummate the
purchase are
a. recorded as a deferred asset and amortized over a period not to exceed 15 years
b. expensed if immaterial but capitalized and amortized if over 2% of the acquisition price
c. expensed in the period of the purchase
d. included as part of the price paid for the company purchased
ANSWER: c
RATIONALE: Direct costs of the acquisition, such as professional fees incurred to negotiate and
consummate the purchase, are expensed in the period of purchase. Costs related to the
issuance of securities related to the purchase may be deducted from the value assigned to
paid-in capital in excess of par.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.1-3
10. Which of the following costs of a business combination can be deducted from the value assigned to paid-in capital in
excess of par?
a. Direct and indirect acquisition costs.
b. Direct acquisition costs.
c. Direct acquisition costs and stock issue costs if stock is issued as consideration.
d. Stock issue costs if stock is issued as consideration.
ANSWER: d
RATIONALE: Stock issue costs can be deducted from the value assigned to paid-in capital in excess of par
when stock is issued as consideration. All other direct and indirect acquisition costs are
expensed.
DIFFICULTY: E
LEARNING OBJECTIVES: ADAC.FISC.1-3
11. When determining the fair values of assets acquired in an acquisition, the highest level of measurement per GAAP is
a. adjusted market value based on prices of similar assets.
b. unadjusted market values in an actively traded market.
c. based on discounted cash flows.
d. the entity’s best estimate of an exit or sale value.
ANSWER: b
RATIONALE: FASB provides a hierarchy of values where the highest level measurement possible should be
used. The levels are as follows:
Level 1 - Unadjusted quoted market values in an actively traded market.
Level 2 - Adjusted market value based on prices of similar assets or on observable other
inputs such as interest rates.
Level 3 - Fair value based on unobservable inputs such as the entity’s best estimate of an exit
value.
DIFFICULTY: E
LEARNING OBJECTIVES: ADAC.FISC.1-3
12. Larry’s Liquor acquired the net assets of Drake’s Drinks in exchange for cash. The acquisition price exceeds the fair
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, Chapter 01—Business Combinations: New Rules for a Long-Standing Business Practice
value of the net assets acquired. How should Larry’s Liquor determine the amounts to be reported for the plant and
equipment, and for long-term debt of the acquired Drake’s Drinks?
Plant and Equipment Long-Term Debt
a. Fair value Drake's carrying amount
b. Fair value Fair value
c. Drake's carrying amount Fair value
d. Drake's carrying amount Drake's carrying amount
ANSWER: b
RATIONALE: All assets acquired and liabilities assumed in an acquisition should be recorded at fair value.
DIFFICULTY: M
LEARNING OBJECTIVES: ADAC.FISC.1-4
13. Crystal Co. purchased all of the common stock of Sill Corp. on January 1 of the current year. Five years prior to the
acquisition, Sill Corp. had issued 30-year bonds bearing an interest rate of 8%. At the time of the acquisition, the
prevailing interest rate for similar bonds was 5%. These bonds should be included in the consolidated balance sheet at
a. face value.
b. at a value higher than Sill’s recorded value due to the change in interest rates.
c. at a value lower than Sill’s recorded value due to the change in interest rates.
d. at Sill’s recorded value.
ANSWER: b
RATIONALE: All assets acquired and liabilities assumed should be recorded at their fair values. A change
in interest rates may result in a market value that is different than the recorded value of the
bonds. Generally, when interest rates fall, prices on bonds with higher stated interest rates
will increase as investors are generally willing to pay more for the higher rate of return.
DIFFICULTY: D
LEARNING OBJECTIVES: ADAC.FISC.1-4
14. ACME Co. paid $110,000 for the net assets of Comb Corp. At the time of the acquisition the following information
was available related to Comb's balance sheet:
Book Value Fair Value
Current Assets $50,000 $ 50,000
Building 80,000 100,000
Equipment 40,000 50,000
Liabilities 30,000 30,000
What is the amount recorded by ACME for the Building?
a. $110,000
b. $20,000
c. $80,000
d. $100,000
ANSWER: d
RATIONALE: Identifiable assets and liabilities of the acquiree are recorded at fair value.
DIFFICULTY: E
LEARNING OBJECTIVES: ADAC.FISC.1-4
15. ABC Co. is acquiring XYZ Inc. XYZ has the following intangible assets:
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