Chapter 1
BUSINESS COMBINATIONS
Answers to Questions
1 A business combination is a union of business entities in which two or more previously
separate and independent companies are brought under the control of a single
management team. Three situations establish the control necessary for a business
combination, namely, when one or more corporations become subsidiaries, when one
company transfers its net assets to another, and when each combining company transfers
its net assets to a newly formed corporation.
2 The dissolution of all but one of the separate legal entities is not necessary for a business
combination. An example of one form of business combination in which the separate
legal entities are not dissolved is when one corporation becomes a subsidiary of another.
In the case of a parent-subsidiary relationship, each combining company continues to
exist as a separate legal entity even though both companies are under the control of a
single management team.
3 A business combination occurs when two or more previously separate and independent
companies are brought under the control of a single management team. Merger and
consolidation in a generic sense are frequently used as synonyms for the term business
combination. In a technical sense, however, a merger is a type of business combination in
which all but one of the combining entities are dissolved and a consolidation is a type of
business combination in which a new corporation is formed to take over the assets of two
or more previously separate companies and all of the combining companies are dissolved.
4 Goodwill arises in a business combination accounted for under the acquisition method
when the cost of the investment (fair value of the consideration transferred) exceeds the
fair value of identifiable net assets acquired. Under GAAP, goodwill is not amortized for
financial reporting purposes and will have no effect on net income, unless the goodwill is
deemed to be impaired. If goodwill is impaired, a loss will be recognized.
,5 A bargain purchase occurs when the acquisition price is less than the fair value of the
identifiable net assets acquired. The acquirer records the gain from a bargain purchase as
an ordinary gain during the period of the acquisition. The gain equals the difference
between the investment cost and the fair value of the identifiable net assets acquired.
,SOLUTIONS TO EXERCISES
Solution E1-1
1 a
2 b
3 a
4 c
Solution E1-2 [AICPA adapted]
1 a
Plant and equipment should be recorded at the $220,000 fair value.
2 c
Investment cost $1,600,000
Less: Fair value of net assets
Cash $ 160,000
Inventory 380,000
Property and equipment — net 1,120,000
Liabilities (360,000) 1,300,000
Goodwill $ 300,000
, Solution E1-3
Stockholders’ equity — Pal Corporation on January 2
Capital stock, $10 par, 1,200,000 shares outstanding $ 12,000,000
[$6,000,000 + $6,000,000]
Other paid-in capital
[$800,000 + $6,000,000 – $20,000] 6,780,000
Retained earnings [$2,400,000 - $40,000] 2,360,000
Total stockholders’ equity $21,140,000
Entry to record combination
Investment in Sip 12,000,000
Capital stock, $10 par 6,000,000
Other paid-in capital 6,000,000
Investment expense 40,000
Other paid-in capital 20,000
Cash 60,000
Check: Net assets per books (book value) $15,200,000
Goodwill and write-up of assets 6,000,000
Less: Expense of direct costs (40,000)
Less: Issuance of stock (20,000)
BUSINESS COMBINATIONS
Answers to Questions
1 A business combination is a union of business entities in which two or more previously
separate and independent companies are brought under the control of a single
management team. Three situations establish the control necessary for a business
combination, namely, when one or more corporations become subsidiaries, when one
company transfers its net assets to another, and when each combining company transfers
its net assets to a newly formed corporation.
2 The dissolution of all but one of the separate legal entities is not necessary for a business
combination. An example of one form of business combination in which the separate
legal entities are not dissolved is when one corporation becomes a subsidiary of another.
In the case of a parent-subsidiary relationship, each combining company continues to
exist as a separate legal entity even though both companies are under the control of a
single management team.
3 A business combination occurs when two or more previously separate and independent
companies are brought under the control of a single management team. Merger and
consolidation in a generic sense are frequently used as synonyms for the term business
combination. In a technical sense, however, a merger is a type of business combination in
which all but one of the combining entities are dissolved and a consolidation is a type of
business combination in which a new corporation is formed to take over the assets of two
or more previously separate companies and all of the combining companies are dissolved.
4 Goodwill arises in a business combination accounted for under the acquisition method
when the cost of the investment (fair value of the consideration transferred) exceeds the
fair value of identifiable net assets acquired. Under GAAP, goodwill is not amortized for
financial reporting purposes and will have no effect on net income, unless the goodwill is
deemed to be impaired. If goodwill is impaired, a loss will be recognized.
,5 A bargain purchase occurs when the acquisition price is less than the fair value of the
identifiable net assets acquired. The acquirer records the gain from a bargain purchase as
an ordinary gain during the period of the acquisition. The gain equals the difference
between the investment cost and the fair value of the identifiable net assets acquired.
,SOLUTIONS TO EXERCISES
Solution E1-1
1 a
2 b
3 a
4 c
Solution E1-2 [AICPA adapted]
1 a
Plant and equipment should be recorded at the $220,000 fair value.
2 c
Investment cost $1,600,000
Less: Fair value of net assets
Cash $ 160,000
Inventory 380,000
Property and equipment — net 1,120,000
Liabilities (360,000) 1,300,000
Goodwill $ 300,000
, Solution E1-3
Stockholders’ equity — Pal Corporation on January 2
Capital stock, $10 par, 1,200,000 shares outstanding $ 12,000,000
[$6,000,000 + $6,000,000]
Other paid-in capital
[$800,000 + $6,000,000 – $20,000] 6,780,000
Retained earnings [$2,400,000 - $40,000] 2,360,000
Total stockholders’ equity $21,140,000
Entry to record combination
Investment in Sip 12,000,000
Capital stock, $10 par 6,000,000
Other paid-in capital 6,000,000
Investment expense 40,000
Other paid-in capital 20,000
Cash 60,000
Check: Net assets per books (book value) $15,200,000
Goodwill and write-up of assets 6,000,000
Less: Expense of direct costs (40,000)
Less: Issuance of stock (20,000)
