Test Bank for Advanced Financial Accounting Canadian 7th Edition By Beechy

Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 1) Which of the following is not a business combination? A) Statutory amalgamation B) Joint venture C) A company's purchase of 100% of another company's net assets D) A company's purchase of 80% of another company's voting shares Answer: B Page Ref: 86-88 Learning Obj.: 3.1, 3.2 Difficulty: Easy 2) Under IFRS 3, Business Combinations, which method must be used to account for business combinations? A) Purchase method B) Pooling-of-interests method C) Acquisition method D) New entity method Answer: C Page Ref: 88 Learning Obj.: 3.3 Difficulty: Easy 3) After an exchange of shares in a business combination, each group of shareholders held 50% of the voting rights. Which of the following factors should be considered in determining the acquirer? A) Head office location B) Composition of the board of directors C) If there are material transactions between the combining companies D) Which company initiated the combination Answer: B Page Ref: 90 Learning Obj.: 3.3 Difficulty: Moderate 4) Ha Ltd. and Hee Ltd. exchanged shares in a business combination. After the share exchange, each company held the same number of voting shares. Which of the following statements is true? A) The company with the highest net assets is considered the acquirer. B) The companies must ask the courts to decide which company is the acquirer. C) A number of factors must be considered to determine which company is the acquirer. D) There is no acquirer as this is not a proper business combination. Answer: C Page Ref: 90 Learning Obj.: 3.3 Difficulty: Moderate Copyright © 2014 Pearson Canada Inc. 3-1 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 5) How should the transaction costs of issuing shares in an acquisition be recognized? A) Expensed B) Capitalized as part of the cost of the shares C) Deducted in total from shareholders' equity D) Deducted from shareholders' equity, net of related income tax benefits Answer: D Page Ref: 91 Learning Obj.: 3.3 Difficulty: Moderate 6) How should the cost of issuing debt in an acquisition be recognized? A) Expensed B) Amortized over the term of the debt C) Deducted from the value of the debt D) Deducted from shareholders' equity Answer: C Page Ref: 91 Learning Obj.: 3.3 Difficulty: Moderate 7) How should accounting fees for an acquisition be treated? A) Expensed in the period of acquisition B) Capitalized as part of the acquisition cost C) Deferred and amortized D) Deferred until the company is disposed of or wound-up Answer: A Page Ref: 91 Learning Obj.: 3.3 Difficulty: Moderate 8) Thad Ltd. acquired 100% of the common shares of Zoe Co. for $560,000. At the time of acquisition, Zoe had the following: In this acquisition, how much goodwill has been created? A) $0 B) $22,000 C) $35,000 Book Value Fair Value Identifiable assets $1,484,000 $1,518,000 Identifiable liabilities 980,000 980,000 D) $56,000 Answer: B Page Ref: 94-96 Learning Obj.: 3.3 Difficulty: Moderate 9) Cheers Co. Tapp Ltd. Current assets $ 240,000 $ 40,000 Net capital assets 400,000 240,000 $ 640,000 $ 280,000 Current liabilities $ 168,000 $ 140,000 Copyright © 2014 Pearson Canada Inc. 3-2 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations Cheers acquired 100% of Tapp's shares for $150,000. On the acquisition date, the fair value of the current assets and the net capital assets of Tapp Ltd. were $104,000 and $216,000, respectively. The fair value of the liabilities equalled their book value. What is the amount of goodwill created in this acquisition? A) $(24,000) B) $ 0 C) $18,000 D) $40,000 Answer: C Page Ref: 94-96 Learning Obj.: 3.3 Difficulty: Moderate 10) What is the most common valuation method used for intangible assets? A) Market-based B) Income-based C) Cost-based D) Amortized cost Answer: B Page Ref: 94 Learning Obj.: 3.3 Difficulty: Moderate 11) How should negative goodwill be shown on the consolidated financial statements of the acquirer? A) As a gain on the statement of comprehensive income B) As a loss on the statement of comprehensive income C) As a liability on the statement of financial position D) As a separate amount under shareholders' equity on the statement of financial position Answer: A Page Ref: 96 Learning Obj.: 3.3 Long-term debt 80,000 48,000 Share capital 360,000 50,000 Retained earnings 32,000 42,000 $ 640,000 $ 280,000 Difficulty: Moderate Copyright © 2014 Pearson Canada Inc. 3-3 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 12) Sya Ltd. acquired all the assets and liabilities of Littman Ltd. by issuing common shares to Littman. After this transaction, Littman owned 30% of Sya's outstanding shares. Which of the following statements is true? A) Littman is now a subsidiary of Sya. B) This is an intercorporate investment for Sya. C) Sya does not need to prepare consolidated financial statements. D) Sya should use the equity method to reflect its investment in Littman. Answer: C Page Ref: 97-99 Learning Obj.: 3.3 Difficulty: Moderate 13) Sya Ltd. acquired all the assets and liabilities of Littman Ltd. by issuing common shares to Littman. After this transaction, Littman owned 30% of Sya's outstanding shares. How should Sya record Littman's assets and liabilities on its books? A) At their original cost B) At their net book value C) At their fair market value D) At their fair market value plus an allocated share of goodwill to each item Answer: C Page Ref: 97-99 Learning Obj.: 3.4 Difficulty: Easy 14) Sya Ltd. acquired all the assets and liabilities of Littman Ltd. by issuing common shares to Littman. After this transaction, Littman owned 30% of Sya's outstanding shares. Which of the following statements is true? A) Littman Ltd. ceases to exist. B) Littman must record its receipt of Sya shares using the equity method. C) Sya must prepare single-entity and consolidated financial statements. D) Sya should not treat this transaction as an intercorporate investment. Answer: D Page Ref: 97-99 Learning Obj.: 3.3, 3.4 Difficulty: Moderate 15) Able Ltd. offers to buy shares from the existing shareholders of Wei Co. at a premium price. The current management and board of directors of Wei have let the Wei shareholders know that they do not approve of this. This is an example of a(n) ________. A) open market purchase B) hostile takeover C) poison pill strategy D) reverse takeover Answer: B Page Ref: 99 Learning Obj.: 3.2 Difficulty: Easy Copyright © 2014 Pearson Canada Inc. 3-4 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 16) Perez Co. plans to acquire Roo Co. Roo has substantial depreciable assets that have fair values in excess of their book values. Considering only the income tax impact, which of the following statements is true? A) Perez would prefer to purchase Roo's assets and Roo would prefer to sell its shares to Perez. B) Perez would prefer to purchase Roo's shares and Roo would prefer to sell its assets to Perez. C) Both Perez and Roo would prefer Perez to purchase Roo's shares. D) Both Perez and Roo would prefer Perez to purchase Roo's assets. Answer: A Page Ref: 100 Learning Obj.: 3.3, 3.4 Difficulty: Moderate 17) Perez Co. acquired Roo Co. in a business combination. Roo issued new shares to Perez's shareholders in exchange for their outstanding shares. What type of share exchange is this? A) Direct exchange B) Indirect exchange C) Hostile takeover D) Reverse takeover Answer: D Page Ref: 101-102 Learning Obj.: 3.2 Difficulty: Easy 18) Perez Co. acquired Roo Co. in a business combination. Perez issued new shares to Roo's shareholders in exchange for their outstanding shares. What type of share exchange is this? A) Direct exchange B) Indirect exchange C) Hostile takeover D) Reverse takeover Answer: A Page Ref: 101 Learning Obj.: 3.2 Difficulty: Easy 19) At December 31, 20X0, Crowe Company has 80,000 common shares outstanding while Dylan Inc. has 40,000 common shares outstanding. Crowe wishes to gain control over Dylan and will enter into a reverse takeover of Dylan to gain Dylan's listing on the stock exchange. In order to facilitate the reverse takeover, which of the following would have to occur? A) Dylan would have to issue more than 40,000 shares. B) Dylan would have to issue less than 40,000 shares. C) Crowe would have to issue less than 80,000 shares. D) Crowe would have to issue more than 80,000 shares. Answer: A Page Ref: 102-103 Learning Obj.: 3.3 Difficulty: Difficult Copyright © 2014 Pearson Canada Inc. 3-5 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 20) Dupuis Ltd. acquired Waul Ltd. through an exchange of shares. How should Waul record this on its books? A) Waul should debit an "Investment by Dupuis" account and credit its share capital account. B) Waul should debit an "Investment by Dupuis" account and remove all its asset and liability accounts. C) Waul should close all its balance sheet accounts. D) No entry should be made. Answer: D Page Ref: 103-104 Learning Obj.: 3.3, 3.4 Difficulty: Moderate 21) Cheers Co Book Value Tapp Ltd Book Value Tapp Ltd Fair Value Current assets $ 512,000 $ 62,400 $ 65,600 Net capital assets 448,000 97,600 110,400 $ 960,000 $ 160,000 Current liabilities $ 96,000 $ 12,800 12,800 Long-term debt 288,000 35,200 40,000 Share capital 320,000 64,000 Retained earnings _256,000 _48,000 $960,000 $ 160,000 Cheers acquired 100% of Tapp's shares for $144,000. The condensed statements of financial position for Cheers and Tapp are given above, as well as the fair values of Tapp's assets and liabilities on the acquisition date. On Cheers's consolidated statement of financial position at the acquisition date, what is the total shareholders' equity? A) $576,000 B) $624,000 C) $688,000 D) $11,888,000 Answer: A Page Ref: 105-110 Learning Obj.: 3.5, 3.6 Difficulty: Moderate Copyright © 2014 Pearson Canada Inc. 3-6 22) Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations Cheers Co Book Value Tapp Ltd Book Value Tapp Ltd Fair Value Current assets $ 512,000 $ 62,400 $ 65,600 Net capital assets 448,000 97,600 110,400 $ 960,000 $ 160,000 Current liabilities $ 96,000 $ 12,800 12,800 Long-term debt 288,000 35,200 40,000 Share capital 320,000 64,000 Retained earnings _256,000 _48,000 $960,000 $ 160,000 Cheers acquired 100% of Tapp's shares for $144,000. The condensed statements of financial position for Cheers and Tapp are given above, as well as the fair values of Tapp's assets and liabilities on the acquisition date. What is the amount of the goodwill on the acquisition? A) $0 B) $11,200 C) $20,800 D) $32,000 Answer: C Page Ref: 105-110 Learning Obj.: 3.5, 3.6 Difficulty: Moderate 23) There are a number of possible approaches to reporting consolidated financial statements after one company acquires control over another. Which of the following methods reports the consolidated amounts by adding together the carrying values of the assets and liabilities of the parent and the subsidiary? A) Pooling-of-interests method B) Acquisition method C) Purchase method D) New entity method Answer: A Page Ref: 105-106 Learning Obj.: 3.5 Difficulty: Easy 24) What type of business combination is accounted for in a manner that is essentially the same as the pooling-of-interests method? A) Statutory amalgamation B) Corporate restructuring C) Reverse takeover D) Hostile takeover Answer: B Page Ref: 107 Learning Obj.: 3.5 Difficulty: Moderate Copyright © 2014 Pearson Canada Inc. 3-7 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 25) Which of the following is not a reason why a private enterprise may be acquired as a bargain purchase? A) It is a family business and the next generation does not want to continue the business. B) The owner has health problems and does not have a successor. C) The business only has equity financing and has no debt financing. D) The owner is no longer interested in the business. Answer: C Page Ref: 111 Learning Obj.: 3.6 Difficulty: Moderate 26) How is negative goodwill reported on financial statements? A) On the consolidated SFP as "an excess of fair value over cost of assets acquired" under shareholders' equity B) On the consolidated SFP as "negative goodwill" between the liabilities and shareholders' equity C) On the consolidated SCI as "negative goodwill" D) On the consolidated SCI as a "gain on bargain purchase" Answer: D Page Ref: 110-111 Learning Obj.: 3.6 Difficulty: Moderate 27) Which of the following statements is not true about revaluation accounting? A) Revaluation must be done regularly. B) Revaluation can be applied to tangible assets whose fair values can be reliably measured. C) Revaluation can be applied to intangible assets if the assets have an active market. D) Revaluation is applied to individual assets. Answer: D Page Ref: 116 Learning Obj.: 3.8 Difficulty: Moderate 28) What does push-down accounting refer to? A) Writing down assets where value is impaired B) Applying the lower of cost or market approach C) Recording fair values on a subsidiary's books after a business combination D) Recording all consolidation adjustments on the books of the subsidiary Answer: C Page Ref: 116 Learning Obj.: 3.8 Difficulty: Moderate Copyright © 2014 Pearson Canada Inc. 3-8 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 29) Which accounting method yields the same results as push-down accounting? A) Equity method B) Cost method C) Consolidation D) Revaluation Answer: D Page Ref: 116 Learning Obj.: 3.8 Difficulty: Moderate 30) Nashman Ltd. is a private enterprise with five subsidiaries. Which of the following statements is true? A) Nashman must prepare consolidated financial statements. B) Nashman should report all subsidiaries on the same basis. C) Nashman must use the cost basis to report all subsidiaries. D) Nashman can choose the subsidiaries it wishes to include in its consolidated financial statements. Answer: B Page Ref: 117-118 Learning Obj.: 3.5 Difficulty: Moderate 31) How is negative goodwill treated in accounting for a joint venture in the year of acquisition? A) Included in the investor's equity in the earnings of the investee B) Included in the carrying value of the investment C) Allocated among the assets and liabilities D) Shown as a line item on the SFP Answer: A Page Ref: 117 Learning Obj.: 3.9 Difficulty: Moderate Copyright © 2014 Pearson Canada Inc. 3-9 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 32) On December 31, 20X5, CI Co. purchased 100% of the outstanding common shares of SA Ltd. for $1,500,000 in cash; 80% of the cash was obtained by issuing a five-year note payable. The statements of financial position of CI and SA immediately before the acquisition and issuance of the notes payable were as follows (in 000s): Book Value Cash $360 Accounts receivable 520 Inventory 800 Fair Value $,000 $380 1,200 Property, plant, and equipment Current liabilities Long-term liabilities Common shares Retained earnings Required: 1,820 $3,500 $ 380 1,200 500 1,420 $3,500 CI SA ____ Book Fair Value Value $200 $ 1,420 1,520 $2,400 $260 $260 600 540 $2,400 Prepare the journal entry that CI will post to record the acquisition of CI. Prepare the consolidated statement of financial position for CI immediately following the acquisition of SA. Copyright © 2014 Pearson Canada Inc. 3-10 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations Answer: Measurement: Calculation of goodwill (in 000s) Consideration given Consideration received: Fair value of net assets acquired: Cash $200 Accounts receivable 380 Inventories 450 Property, plant, and equipment 1,520 Current liabilities (260) Long-term liabilities (1,030) Goodwill CI would have made the following entry to record the acquisition: Dr. Investment in SA Cr. Cash 1,500 × 20% Cr. Note payable 80% × 1,500 CI Co. Consolidated Statement of Financial Position December 31, 20X5 (in 000s) Cash (360 - 300 + 200) Accounts receivable (520 + 380) Inventory (800 + 450) Property, plant, and equipment (1,820 + 1,520) Goodwill Current liabilities (380 + 260) Long-term liabilities (1,200 + 1,200 + 1,030) Common shares Retained earnings Page Ref: 108-112 Learning Obj.: 3.6 Difficulty: Moderate $ 260 900 1,250 3,340 240 $5,990 $ 640 3,430 500 1,420 $5,990 $1,500 1,260 $ 240 1,500 300 1,200 Copyright © 2014 Pearson Canada Inc. 3-11 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 33) On December 31, 20X5, CI Co. purchased 100% of the outstanding common shares of SA Ltd. for $1,100,000 in cash; 80% of the cash was obtained by issuing a five-year note payable. The statements of financial position of CI and SA immediately before the acquisition and issuance of the notes payable were as follows (in 000s): SA Book Fair Value Value $200 $ 1,420 1,520 $2,400 $260 $260 600 540 $2,400 Property, plant, and equipment Current liabilities Long-term liabilities Common shares Retained earnings Required: 1,820 $3,500 $ 380 1,200 500 1,420 $3,500 CI Book Fair Value $360 Accounts receivable 520 500 Value Cash $360 Inventory 800 880 2,000 $380 1,200 Prepare the journal entry that CI will post to record the acquisition of SA. Prepare the consolidated statement of financial position for CI immediately following the acquisition of SA. Answer: Measurement: Calculation of goodwill (in 000s) Consideration given Consideration received: Fair value of net assets acquired: Cash Accounts receivable Inventories Property, plant, and equipment Current liabilities Long-term liabilities Goodwill $200 380 450 1,520 (260) (1,030) $1,100 1,260 $ (160) This negative goodwill will be reported as a gain on bargain purchase and recognized in the consolidated statement of comprehensive income issued by CI. CI would have made the following entry to record the acquisition: Dr. Investment in SA 1,100 Cr. Cash 1,100 × 20% 220 Cr. Note payable 80% × 1,100 880 Copyright © 2014 Pearson Canada Inc. 3-12 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations CI Co. Consolidated Statement of Financial Position December 31, 20X5 (in 000s) Cash (360 - 220+ 200) Accounts receivable (520 + 380) Inventory (800 + 450) Property, plant, and equipment (1,820 + 1,520)3,340 $5,830 Current liabilities (380 + 260) $ 640 Long-term liabilities (1,200 + 880 + 1,030) 3,110 Common shares 500 Retained earnings 1,420 + 160 1,580 Page Ref: 103-105, 108-110 Learning Obj.: 3.6 Difficulty: Moderate $ 340 900 1,250 $5,830 Copyright © 2014 Pearson Canada Inc. 3-13 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 34) On December 31, 20X6, the statements of financial position of the Power Company and the Pro Company are as follows: (in 000s) Power Cash $ 500 Accounts receivable 1,500 Inventories 2,000 Pro $ 800 1,700 1,500 4,000 $8,000 $ 400 500 1,000 1,500 4,600 $8,000 (FV) $4,300 $ 550 Property, plant, and equipment (net) Total assets Current liabilities Long-term liabilities Common shares Contributed surplus Retained earnings Total liabilities and equities 2,500 $6,500 $ 700 800 2,500 800 1,700 $6,500 Power Company has 100,000 shares of common stock outstanding. Pro Company has 45,000 shares outstanding. On January 1, 20X7, Power issued an additional 90,000 shares of common stock in exchange for all the outstanding shares of Pro. All assets and liabilities have book values equal to fair values, except as noted above. In addition, Pro has a patent that has an appraised fair value of $450. Market value of the new shares issued was $95 per share at the date of acquisition. Required: What is the amount of goodwill to be recorded for this business combination? Prepare the journal entry that Power would record on January 1, 20X7, related to this acquisition. Prepare the consolidated statement of financial position at January 1, 20X7. Answer: Calculation of goodwill (in 000s): Fair value of consideration (90,000 shares @ $95) Consideration received: Fair value of net assets acquired: $8,550 Cash Accounts receivable Inventories Property, plant, and equipment Patent Current liabilities Long-term liabilities Goodwill $800 1,700 1,500 4,300 450 (400) (550) 7,800 $ 750 Copyright © 2014 Pearson Canada Inc. 3-14 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations Journal entry recorded by Power to record the acquisition: Dr. Investment in Pro 8,550 Cr. Common shares Power Company 8,550 Consolidated Statement of Financial Position January 1, 20X7 (in 000s) Cash (500 + 800) Accounts receivable (1,500 + 1,700) Inventories (2,000 + 1,500) Property, plant, and equipment (2,500 + 4,300) Patent Goodwill Total assets $ 1,300 3,200 3,500 6, $16,000 $ 1,100 1,350 11,050 800 1,700 $16,000 Current liabilities (700 + 400) Long-term liabilities (800 + 550) Common shares 2,500 + 8,550 Contributed surplus Retained earnings Total liabilities and equities Page Ref: 13-105 and 108-110 Learning Obj.: 3.4, 3.6 Difficulty: Moderate Copyright © 2014 Pearson Canada Inc. 3-15 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 35) On December 31, 20X6, the statements of financial position of the Power Company and the Pro Company are as follows: (in 000s) Power Cash $ 500 Accounts receivable 1,500 Inventories 2,000 Pro $ 800 1,700 1,500 4,000 $8,000 $ 400 500 1,000 1,500 4,600 $8,000 (FV) $4,300 $ 550 Property, plant, and equipment (net) Total assets Current liabilities Long-term liabilities Common shares Contributed surplus Retained earnings Total equities 2,500 $6,500 $ 700 800 2,500 800 1,700 $6,500 Power Company has 100,000 shares of common stock outstanding. Pro Company has 45,000 shares outstanding. On January 1, 20X7, Power issued an additional 90,000 shares of common stock in exchange for all the net assets of Pro. All assets and liabilities have book value equal to fair values, except as noted. In addition, Pro has a patent that has an appraised fair value of $450. Market value of the new shares issued was $95 per share at the date of acquisition. Required: A) What is the amount of goodwill to be recorded for this business combination? Prepare the journal entry that Power would record on January 1, 20X7, related to this acquisition. In this case, who are the shareholders, and what are their percentage holdings on January 1, 20X7? Prepare the statement of financial position for Power as at January 1, 20X7. B) How would your answer differ if Power had purchased the shares rather than the net assets of Pro Company? In this case, who are the shareholders and what are their percentage holdings on January 1, 20X7? Copyright © 2014 Pearson Canada Inc. 3-16 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations Answer: Part A Calculation of goodwill (in 000s): Fair value of consideration (90,000 shares @ $95) Consideration received: Fair value of net assets acquired: Cash Accounts receivable Inventories Property, plant, and equipment Patent Current liabilities Long-term liabilities Goodwill $800 1,700 1,500 4,300 450 (400) (550) $8,550 7,800 $ 750 400 550 8,550 Journal entry recorded by Power to record the acquisition: Dr. Cash Accounts receivable Inventories Property, plant, and equipment Patent Goodwill Cr. Current liabilities Long-term liabilities Common shares $800 1,700 1,500 4,300 450 750 Copyright © 2014 Pearson Canada Inc. 3-17 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations The shareholders of Power Company at January 1, 20X7: The original shareholders of Power hold 100,000 common shares, representing 52.6% (100,000/190,000), and Pro Company owns 90,000 shares, representing 47.3%. In effect, Power is now an investee of Pro. Power Company Statement of Financial Position At January 1, 20X7 (in 000s) Cash (500 + 800) Accounts receivable (1,500 + 1,700) Inventories (2,000 + 1,500) Property, plant, and equipment (2,500 + 4,300) Patent Goodwill Total assets Current liabilities (700 + 400) Long-term liabilities (800 + 550) Common shares 2,500 + 8,550 Contributed surplus Retained earnings Part B $ 1,300 3,200 3,500 6, $16,000 $ 1,100 1,350 11,050 800 1,700 $16,000 If Power purchased the shares rather than the net assets of Pro Company, the journal entry prepared by Power would be: Journal entry recorded by Power to record the acquisition: Dr. Investment in Pro 8,550 Cr. Common shares 8,550 The assets and liabilities would remain on Pro's books and only on consolidation would the assets and liabilities of Pro be added to the assets and liabilities of Power. In this case, the shares of Power Company are owned as follows on January 1, 20X7: The original shareholders of Power hold 100,000 common shares, representing 52.6% (100,000/190,000), and the original shareholders of Pro own 90,000 shares, representing 47.3%. Pro is a subsidiary of Power. Page Ref: 87; 97-100; 103-104; 109-110 Learning Obj.: 3.2, 3.4, 3.6 Difficulty: Difficult Copyright © 2014 Pearson Canada Inc. 3-18 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 36) Hurricane Inc. wants to acquire 100% of the net assets of Flood Inc. using all cash consideration. From Flood's shareholders' point of view, what are the advantages and disadvantages of Hurricane purchasing shares rather than net assets of Flood? Answer: The advantages of a purchase of shares are the following: 1. Flood's shareholders may ask for a premium to be paid on the price of the shares, since Hurricane wants to gain 100% ownership and wants to entice all of Flood's shareholders to accept the offer. 2. The proceeds will go directly to Flood's shareholders and they can then use the cash for whatever reasons they wish. The disadvantages of a purchase of shares are the following: 1. Flood's shareholders will be subject to capital gains tax on the proceeds of disposal of these shares. 2. If Hurricane cannot get all 100% of the shareholders to agree to sell, then the deal may fall through unless Hurricane will settle for something less than 100% ownership. The advantage of a net asset purchase is the following: 1. With a net asset purchase, since the sale is made by Flood itself, it may be easier to get full support from the board of directors to have the deal go through, rather than trying to convince the individual shareholders. The disadvantages of a net asset purchase are the following: 1. Proceeds from the sale will go to the company rather than the individual shareholders. In this case, it will be up to the board of directors to decide what should happen with the proceeds. The board could decide to issue a dividend for the amount, wind up the company, and issue a liquidating dividend; or reinvest the proceeds in some other business. 2. Gains will be subject to tax at higher rates in Flood. Higher taxes can result if part of the gains are taxed as recaptured CCA, sale of inventory, or a sale of intangible assets. This may leave less net proceeds available to be paid out to Flood's shareholders. Page Ref: 99-101 Learning Obj.: 3.2, 3.3 Difficulty: Difficult Copyright © 2014 Pearson Canada Inc. 3-19 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 37) On January 1, 20X7, Falcon acquired the net assets of Intra for $3,400,000 with the issue of shares. The statement of financial position for Intra at the date of acquisition is shown below, together with estimates of the fair values of Intra's recorded assets and liabilities. Intra Corp Statement of Financial Position as at December 31, 20X6 Book value $ 000's Fair value $ 000's Assets Cash 350 350 Accounts receivable 180 170 Inventories 330 310 Property, plant, and equipment 3,465 3,155 Development projects 150 565 Other investments 20 45 Total assets 4,495 Liabilities Accounts payable and accrued liabilities 180 180 Long-term debt 680 660 Common shares 1,525 Retained earnings 2,110 Total liabilities and shareholders' equity 4,495 Required: What is the amount of goodwill to be recorded for this business combination? Prepare the journal entry that Falcon will use to record the business combination. Prepare the statement of financial position for Intra on January 1, 20X7, directly after the transaction is completed. Reconcile the book value of the retained earnings for Intra on December 31, 20X6, to its balance on January 1, 20X7. Explain any differences. Copyright © 2014 Pearson Canada Inc. 3-20 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations Answer: Calculation of goodwill (in 000s): Fair value of consideration paid Consideration received: Fair value of net assets acquired: Cash Accounts receivable Inventories Property, plant, and equipment Development projects Other investments Current liabilities Long-term liabilities Goodwill $, (180) ( 660) $3,400 3,755 $ (355) The "negative goodwill" is a gain in bargain purchase. The journal entry used by Falcon to record the business combination is as follows: Dr. Cash Accounts receivable Inventories Capital assets Development projects Other investments $, Cr. Current liabilities Cr. Long-term liabilities Cr. Gain on bargain purchase (income statement) 355 Cr. Common shares 3,400 Copyright © 2014 Pearson Canada Inc. 3-21 180 660 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations Intra Corp Statement of Financial Position as at January 1, 20X7 Post-transaction (in thousands of $'s) $ Assets Cash Accounts receivable Inventories Capital assets Development projects Other investments Investment in Falcon 3,400 Total assets 3,400 Liabilities Accounts payable and accrued liabilities Long term debt Common shares 1,525 Retained earnings 1,875 Total liabilities and shareholders' equity 3,400 Note: Proof of retained earnings: Book value amount before transaction Excess of fair value over book values: 3,755 - (1,525 + 2,110) Discount on sale (gain on bargain purchase) Retained earnings after transaction Page Ref: 103-105 2,110 120 (355) 1,875 Learning Obj.: 3.4, 3.6 Difficulty: Difficult Copyright © 2014 Pearson Canada Inc. 3-22 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 38) Sugar Corp and Syrup Limited have reached an agreement in principle to combine their operations as of October 1, 20X9. However, the board of directors cannot decide on the best way to accomplish the combination. Below are the alternatives being considered. 1. Sugar acquires the net assets of Syrup for $1,700,000 cash. 2. Sugar acquires only the assets for $2,650,000 cash. 3. Sugar acquires all of the outstanding shares of Syrup by issuing shares with a fair market value of $1,700,000. Syrup has the following assets and liabilities at October 1, 20X9 (in thousands of dollars). $ Cash 50 Accounts receivable 230 Inventory 470 Property, plant, and equipment, net 1,750 Total assets 2,500 Accounts payable 360 Loan payable 650 Common shares 800 Retained earnings 690 Total liabilities and shareholders' equity 2,500 The only item that has a fair value different from its carrying value is the property, plant, and equipment, which has a fair value of $1,900. Required: Explain how each transaction is different from the acquirer's point of view. Prepare the journal entry that would be recorded by Sugar for each these alternatives. Answer: Alternative 1—This transaction is a purchase of net assets and therefore qualifies as a business combination. As a result, goodwill (if any) may arise on this transaction and be recorded. Sugar will record all of the assets and liabilities purchased in its books. Alternative 2—This transaction is a purchase of an asset group only and does not qualify as a business combination. An asset group can have no goodwill. Therefore, this is a "basket purchase" and the price paid will be allocated to the specific assets purchased. Alternative 3—This transaction is the purchase of shares and therefore qualifies as a business combination. Goodwill may arise on this transaction but will be recorded only on consolidation. Sugar will only record the investment in Syrup on its books. Only on consolidation will the individual assets and liabilities of Syrup be shown on Sugar's statement of financial position. Copyright © 2014 Pearson Canada Inc. 3-23 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations Calculation of goodwill (in 000s): Fair value of consideration paid Consideration received: Fair value of net assets acquired: Cash Accounts receivable Inventories Property, plant, and equipment Accounts payable Long-term liabilities Goodwill $ 1,900 (360) ( 650) $1,700 1,640 $ 60 Alternative 1–Journal entry to record the purchase of the net assets of Syrup (in 000s). Dr. Cash $50 Accounts receivable 230 Inventories 470 Property, plant, and equipment 1,900 Goodwill 60 Cr. Accounts payable Long-term liabilities Cash 360 650 1,700 Alternative 2–Journal entry to record the purchase of the assets of Syrup (in 000s). Dr. Cash $50 Accounts receivable 230 Inventories 470 Property, plant, and equipment 1,900 Cr. Cash 2,650 Copyright © 2014 Pearson Canada Inc. 3-24 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations Alternative 3–Journal entry to record the purchase of shares in Syrup (in 000s). Dr. Investment in Syrup 1,700 Cr. Cash Page Ref: 101-103 Learning Obj.: 3.1, 3.4, 3.6 Difficulty: Moderate 1,700 39) Slade Co. has 1,000,000 shares outstanding and is traded on the TSX. On October 1, 20X6, Slade purchased all of the outstanding shares of Print Co. (a private company) by issuing 1,200,000 shares at $50 per share. Required: Explain the legal form of this transaction. What is the transaction in substance? How will this transaction be accounted for? Why might the transaction have been accomplished in this manner? Answer: This is a reverse takeover. The legal parent, Slade, issued the shares and now legally owns all the shares of Print Co. However, after the combination, Print Co.'s former shareholders now own 1.2 million of Slade's shares, giving them 54.5% voting control (1.2/2.2 million shares) of Slade. The substance of this transaction is that control resides with Print Co.'s former shareholders even though the legal form of the combination is that Slade acquired Print. After the reverse takeover, the consolidated statements will be prepared under the legal parent's name (in this example Slade). But the statements will be consolidated from the perspective of Print being the acquirer in substance. So Print is the legal subsidiary, but the acquirer in substance. Slade is the legal parent, but the in-substance acquiree. Likely the reason that a reverse takeover was performed was to allow Print to obtain a stock exchange listing. This saves Print the trouble and expense of applying to the Ontario Securities Commission and the TSX in order to obtain a new listing. Page Ref: 102-103 Learning Obj.: 3.2, 3.3 Difficulty: Difficult Copyright © 2014 Pearson Canada Inc. 3-25 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 40) Ski Ltd. has 500,000 shares outstanding. On July 1, 20X7, Ski purchased all of the outstanding shares of Snow Ltd. The consideration paid by Ski was in the form of 500,000 shares, valued at $20 per share, which was premium of 10% over the market value prior to the announcement. It has been decided that the CEO of the combined company will come from Ski, but the CFO and the COO will come from Snow. The chairman of the board of directors will come from Snow. The board will have six other directors, three from Ski and three from Snow. Required: Define what the acquirer is in a business combination. How would you identify the acquirer in the above transaction? Answer: An acquirer in a business combination is the corporation whose shareholders control the combined entity. In this case, after the combination, the ownership of Ski is as follows: The former shareholders of Ski own 500,000 shares and the former shareholders of Snow also own 500,000. As a result, voting control is evenly split at 50% for each group. No one group has the voting control of the new combined entity. It is necessary to examine other factors to determine who the acquirer is. The other factors include: • Representation on the board—In this case, the chairman is from Snow, and there is equal representation from Ski and Snow for the remaining six directors • Management team—The management team is made up of the CEO from Ski, but the CFO and the COO both come from Snow. Given the above analysis of factors, it would appear that Snow might have control since Snow has majority on the board of directors, including the chairman, and also has two of the three managers on the senior management team. Consequently, Snow would be the acquirer in this combination. Note: This answer will be a judgment call, and students may argue for Ski to have majority, since the CEO is from Ski. Page Ref: 90 Learning Obj.: 3.3 Difficulty: Moderate Copyright © 2014 Pearson Canada Inc. 3-26 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 41) On September 1, 20X7, Spike Limited decided to buy 100% of the outstanding shares of Volley Inc. for $1,200,000, paid for with the issuance of shares. Acquisition costs for the deal totaled $30,000: $20,000 related to the issue of the shares and the remaining amount for legal, valuation, and administrative costs. All of these costs were paid in cash. In addition Spike has agreed to pay an additional $250,000 if the revenues of Volley have a 5% growth over the next two years from the date of the acquisition. It has been determined that the fair value of this contingent consideration is $175,000. The balances showing on the statement of financial position for the two companies at August 31, 20X7, are as follows: Spike $ Volley $ Assets Cash 45,000 20,000 Accounts receivable 65,000 35,000 Inventory 50,000 80,000 Marketable securities 0 45,000 Property, plant, and equipment—net 3,590,000 1,020,000 3,750,000 1,200,000 Liabilities Current liabilities Accounts payable 665,000 280,000 Bonds payable 1,350,000 620,000 Shareholders' equity Common shares 950,000 250,000 Retained earnings 785,000 50,000 3,750,000 1,200,000 After a review of the financial assets and liabilities, Spike determines that some of the assets of Volley have fair values different from their carrying values. These items are listed below: Property, plant, and equipment: fair value is $1,350,000 Patent: fair value is $255,000 Brand name: fair value is $135,000 Required: Determine the amount of goodwill that will be recorded on the business combination. Prepare the consolidated statement of financial position as at September 1, 20X7. Answer: Calculation of goodwill: Fair value of consideration: Issuance of shares Contingent consideration Total consideration paid or payable $1,200,000 175,000 $1,375,000 Copyright © 2014 Pearson Canada Inc. 3-27 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations The acquisition costs are not part of the acquisition. Instead, the costs to issue the shares of $20,000 are deducted from shares issued, and the other costs of $10,000 are expensed. Consideration received: Fair value of net assets acquired: Cash Accounts receivable Inventories Marketable securities Property, plant, and equipment Patent Band name Current liabilities Long-term liabilities Goodwill $20,000 35,000 80,000 45,000 1,350,000 255,000 135,000 (280,000) (620,000) 1,020,000 $ 355,000 Spike Limited Consolidated Statement of Financial Position September 1, 20X7 $ Assets Cash (45 + 20 - 30) 35,000 Accounts receivable (65 + 35) 100,000 Inventory (50 + 80) 130,000 Marketable securities (45) 45,000 Property, plant, and equipment—net (3,590 + 1,350) 4,940,000 Patent 255,000 Brand name 135,000 Goodwill 355,000 Total assets 5,995,000 Liabilities Current liabilities Accounts payable (665 + 280) 945,000 Bonds payable (1,350 + 620) 1,970,000 Contingent payable 175,000 Shareholders' equity Common shares (950 + 1,200 - 20) 2,130,000 Retained earnings (785-10) 775,000 Total liabilities and shareholders' equity 5,995,000 Page Ref: 90-92, 99, 108-110 Learning Obj.: 3.3, 3.4, 3.6 Difficulty: Difficult Copyright © 2014 Pearson Canada Inc. 3-28 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 42) Explain how a business combination could occur with no transfer of consideration. Using the two scenarios below, explain how PCo could gain control of SCo with no transfer of consideration. Scenario 1: SCo currently has 1,000,000 common shares outstanding, and PCo owns 300,000. Scenario 2: SCo currently has 1,000,000 common shares outstanding. Although PCo owns 510,000 of these shares, PCo is unable to exert control due to regulatory restrictions. Answer: A business combination occurs when the acquirer gains control of an acquiree. Examples of how control can be gained with no consideration are as follows: • The acquirer is a minority shareholder. However, the acquiree repurchases enough shares from other shareholders in order that the acquirer now owns more than 50% of the outstanding shares. Using the information from Scenario 1 above, this is how PCo could gain control: SCo repurchases 411,000 shares from shareholders other than PCo. SCo now has 589,000 (1,000,000 - 411,000) shares outstanding. After this transaction, PCo will own 300,000/589,000, giving PCo 51% ownership and therefore control over SCo. • A second method for a company to gain control is in situations where regulations or contracts restrict the acquirer from voting its majority shares. If the restrictions are lifted due to changes in the regulations or contract, the acquirer can then have majority votes and exercise control. Using the information from Scenario 2 above, if the regulatory restrictions are lifted or amended, PCo could then vote its shares and have 51% voting power, which would give it control. Page Ref: 92-93 Learning Obj.: 3.3 Difficulty: Moderate Copyright © 2014 Pearson Canada Inc. 3-29 Beechy, Trivedi, MacAulay Advanced Financial Accounting, Seventh Edition Chapter 3 Business Combinations 43) A company is often purchased for its identifiable intangible assets, which must be measured at fair value at the date of acquisition. Discuss the three methods that are used to determine the fair value of identifiable intangibles. Why are these measurements subjective, and what is the ethical challenge relating to the determination of these values? Answer: Fair value measurements require a lot of judgment. This is particularly true for intangible assets, which are unique for each company. Methods used to determine fair value are as follows: 1. Market-based approach: This valuation uses prices in an active market (if available) and prices for similar assets. In the case of many intangibles, these prices are not available. 2. Income-based approach: This valuation method determines the fair value of the intangible asset by forecasting future economic benefits that will arise from the ownership of this asset. This is the most commonly used approach. 3. Cost-based approach: This method uses the cost base of the intangible. The problem with this approach is that the cost of the intangible likely has no relationship to its fair value. The market-based approach is the most certain. The income-based approach requires many assumptions be made about the future and therefore will be very subjective with a range of fair values that might be ultimately determined. The ethical challenge is that the more value of the consideration that is allocated to the identifiable intangible assets, the lower the goodwill, and vice versa. Goodwill is not amortized, whereas intangible assets with definite lives will be. Consequently, subsequent years' profits will be impacted by the amount of amortization that is recorded on these assets. The more of the consideration that is allocated to goodwill, the higher future earnings will be. From auditors' perspective, because there are ranges of values that might be reasonable, it may be difficult to challenge management on the fair values that have been used to determine goodwill. Page Ref: 94-96 Learning Obj.: 3.3