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Chapter 2
Methods of Accounting for Business Combinations
Multiple Choice
1. Assets and liabilities acquired are recorded at their fair values under
a. The pooling of interests method.
b. The purchase method.
c. Both the purchase and the pooling of interests methods.
d. Neither the purchase nor the pooling of interests methods.
2. Equity shares issued as consideration are recorded at the book value of the acquired shares under
a. The pooling of interests method.
b. The purchase method.
c. Both the purchase and the pooling of interests methods.
d. Neither the purchase nor the pooling of interests methods.
3. Under the purchase method, if the fair values of identifiable net assets exceed the total cost of the
acquired company, the excess should be
a. accounted for as goodwill.
b. allocated to reduce current and long-lived assets.
c. allocated to reduce current assets and classify any remainder as an extraordinary gain.
d. allocated to reduce long-lived assets and classify any remainder as an extraordinary gain.
4. Which of the following statements is correct?
a. The acquired company’s retained earnings become a part of the acquiring company’s retained
earnings under the purchase method.
b. The acquired company’s retained earnings do not become a part of the acquiring company’s
retained earnings under the pooling of interests method.
c. The acquired company’s retained earnings become a part of the acquiring company’s retained
earnings under both methods.
d. None of these.
5. The issuer and combiner companies’ earnings are combined for the full year in which the
combination occurs under
a. the purchase method.
b. the pooling of interests method.
c. both the purchase and pooling of interests methods.
d. neither the purchase nor the pooling of interests methods.
6. Direct costs related to acquisitions are expensed in the year in which incurred under
a. the purchase method.
b. the pooling of interests method.
c. both the purchase and the pooling of interests methods.
d. none of these.
7. Under the pooling of interests method, when the par value of the shares issued by the issuing firm is
less than the total par value of the combining company’s stock, the excess should be
a. deducted from the combined other contributed capital.
b. deducted from the combined retained earnings.
c. added to the combined other contributed capital.
d. added to the combined retained earnings.
2-2 Chapter 2 Methods of Accounting for Business Combinations
8. In a leveraged buyout, the portion of the net assets of the new corporation provided by the
management group is recorded at
a. appraisal value.
b. book value.
c. fair value.
d. lower of cost or market.
9. When the purchase price of an acquired firm is less than the fair value of the identifiable net assets,
all of the following are recorded at fair market value except
a. Assumed liabilities.
b. Current assets.
c. Long-term investments in marketable securities.
d. Long-lived assets.
10. Which of the following costs are accounted for in the same way under both the purchase and
pooling of interests methods?
a. Direct costs incurred in a combination.
b. Indirect costs related to acquisitions.
c. Security issuance costs.
d. None of these.
11. A business combination is accounted for properly as a purchase. Which of the following expenses
related to effecting the business combination should enter into the determination of net income of
the combined corporation for the period in which the expenses are incurred?
Accounting and Overhead allocated
consulting fees to the merger
a. Yes Yes
b. Yes No
c. No Yes
d. No No
12. In a business combination, security issuance costs are deducted from the recorded value of the
security for a
Pooling Purchase
a. Yes Yes
b. Yes No
c. No Yes
d. No No
13. Par Company and Sub Company were combined in a purchase transaction. Par was able to acquire
Sub at a bargain price. The sum of the fair values of identifiable assets acquired less the fair value of
liabilities assumed exceeded cost to Par. After revaluing long-lived assets to zero, there was still
some “negative goodwill.” Proper accounting treatment by Par is to report the amount as
a. paid-in capital.
b. a deferred credit, which is amortized.
c. part of current income in the year of combination.
d. an extraordinary gain.
Chapter 2 Methods of Accounting for Business Combinations 2-3
14. Under a pooling of interests, all types of acquisition expenses are
a. expensed in the period incurred.
b. capitalized and amortized over a discretionary period.
c. considered a part of the total cost of the acquired company.
d. charged to retained earnings when incurred.
15. In a business combination accounted for as a purchase, how should the excess of fair value of net
assets acquired over cost be treated?
a. Amortized as a credit to income over a period not to exceed forty years.
b. Amortized as a charge to expense over a period not to exceed forty years.
c. Amortized directly to retained earnings over a period not to exceed forty years.
d. Allocated as a reduction of long-lived other than investments in marketable securities.
16. P Corporation issued 10,000 shares of common stock with a fair value of $25 per share for all the
outstanding common stock of S Company in a business combination properly accounted for as a
purchase. The fair value of S Company’s net assets on that date was $220,000. P Company also
agreed to issue an additional 2,000 shares of common stock with a fair value of $50,000 to the
former stockholders of S Company as an earnings contingency. Assuming the contingency is met,
the $50,000 fair value of the additional shares issued should be treated as a(n)
a. decrease in noncurrent liabilities of S Company that were assumed by P Company.
b. decrease in consolidated retained earnings.
c. increase in consolidated goodwill.
d. decrease in consolidated other contributed capital.
17. On February 5, Seely Corporation paid $1,500,000 for all the issued and outstanding common stock
of Pod, Inc., in a transaction properly accounted for as a purchase. The book values and fair values
of Pod’s assets and liabilities on February 5 were as follows
Book Value Fair Value
Cash $ 160,000 $ 160,000
Receivables (net) 180,000 180,000
Inventory 315,000 300,000
Plant and equipment (net) 820,000 900,000
Liabilities (350,000) (350,000)
Net assets $1,125,000 $1,190,000
What is the amount of goodwill resulting from the business combination?
a. $-0-.
b. $375,000.
c. $65,000.
d. $310,000.
2-4 Chapter 2 Methods of Accounting for Business Combinations
18. P Company purchased the net assets of S Company for $150,000. On the date of P’s purchase, S
Company had no investments in marketable securities and $20,000 (book and fair value) of
liabilities. The fair values of S Company’s assets, when acquired, were
Current assets $ 80,000
Noncurrent assets 120,000
Total $200,000
How should the $30,000 difference between the fair value of the net assets acquired ($180,000) and
the cost ($150,000) be accounted for by P Company?
a. The noncurrent assets should be recorded at $ 90,000.
b. The $30,000 difference should be credited to retained earnings.
c. The current assets should be recorded at $68,000, and the noncurrent assets should be recorded
at $102,000.
d. A deferred credit of $30,000 should be set up and amortized to income over a period not to
exceed forty years.
19. A business combination occurs when a company acquires an equity interest in another entity and
has:
a. 100% ownership in the entity.
b. more than 50% ownership in the entity.
c. at least 20% ownership in the entity.
d. control over the entity, regardless of the percentage owned.
20. P Co. issued 5,000 shares of its common stock, valued at $200,000, to the former shareholders of S
Company two years after S Company was acquired in an all-stock transaction. The additional
shares were issued because P Company guaranteed the minimum value of the shares that were
issued to S Company on the date of acquisition. P Company will treat the additional shares as a(n)
a. decrease in consolidated retained earnings.
b. increase in consolidated goodwill.
c. decrease in consolidated other contributed capital.
d. decrease in non-current liabilities of S Company assumed by P Company
21. In a business combination in which the total fair value of the identifiable assets acquired over
liabilities assumed is greater than the cost, the excess fair value is:
a. classified as an extraordinary gain.
b. allocated first to reduce proportionately non-current assets, except long-term marketable
securities, and any remaining excess over cost is classified as an extraordinary gain.
c. allocated first to reduce proportionately non-current assets then to non-monetary current assets,
and any remaining excess over cost is classified as a deferred credit.
d. allocated first to reduce proportionately non-current, depreciable assets to zero, and any
remaining excess over cost is classified as a deferred credit.
22. The first step in determining goodwill impairment involves comparing the
a. implied value of a reporting unit to its carrying amount (goodwill excluded).
b. fair value of a reporting unit to its carrying amount (goodwill excluded).
c. implied value of a reporting unit to its carrying amount (goodwill included).
d. fair value of a reporting unit to its carrying amount (goodwill included).
Chapter 2 Methods of Accounting for Business Combinations 2-5
23. If an impairment loss is recorded on previously recognized goodwill due to the transitional goodwill
impairment test, the loss should be treated as a(n):
a. loss from a change in accounting principles.
b. extraordinary loss
c. loss from continuing operations.
d. loss from discontinuing operations.
24. P Company acquires all of the voting stock of S Company for $700,000 cash. The book values of S
Company’s assets are $600,000, but the fair values are $630,000 because land has a fair value above
its book value. Goodwill from the combination is computed as:
a. $100,000.
b. $70,000.
c. $30,000.
d. $0.
25. P Company paid $1,000,000 for the net assets of S Company and S Company was dissolved. The
fair values of S Company’s net assets were $1,250,000. S Company’s only non-current assets were
land and building with fair values of $80,000 and $320,000 respectively. At what value will the
building be recorded by P Company?
a. $320,000.
b. $200,000.
c. $120,000.
d. $0.
From the Jeter 2e Study Guide:
26. What is a bargain purchase?
a. When P’s cost is far above the fair value of S’s net assets acquired
b. When P cannot determine a fair value of its stock issued in the acquisition
c. When P purchases S for less than the fair market value of the net assets acquired
d. When P increases the value of the long-lived assets to reflect its excess cost
27. What is the current technique for the disposition of goodwill acquired in a business
combination?
a. Amortized over some period not to exceed 40 years
b. Amortized over some period not to exceed 20 years
c. Expensed in the year of combination
d. Capitalized at original value unless impairment occurs
Problems
2-1 Balance sheet information for Steve Corporation at January 1, 2004, is summarized as follows:
Current assets $ 230,000 Liabilities $ 300,000
Plant assets 450,000 Capital stock $10 par 200,000
Retained earnings 180,000
$ 680,000 $ 680,000
Steve’s assets and liabilities are fairly valued except for plant assets that are undervalued by
$50,000. On January 2, 2004, Paul Corporation issues 20,000 shares of its $10 par value common
2-6 Chapter 2 Methods of Accounting for Business Combinations
stock for all of Steve’s net assets and Steve is dissolved. Market quotations for the two stocks on
this date are:
Paul common: $28.00
Steve common: $19.50
Paul pays the following fees and costs in connection with the combination:
Finder’s fee $10,000
Costs of registering and issuing stock 5,000
Legal and accounting fees 6,000
Required:
A. Calculate Paul’s investment cost of Steve Corporation.
B. Calculate any goodwill from the business combination.
2-2 Peterson Corporation purchased the net assets of Sanderson Corporation on January 2, 2004 for
$280,000 and also paid $10,000 in direct acquisition costs. Sanderson’s balance sheet on January
1, 2004 was as follows:
Accounts receivable-net $ 90,000 Current liabilities $ 35,000
Inventory 180,000 Long term debt 80,000
Land 20,000 Common stock ($1 par) 10,000
Building-net 30,000 Paid-in capital 215,000
Equipment-net 40,000 Retained earnings 20,000
Total assets $ 360,000 Total liab. & equity $ 360,000
Fair values agree with book values except for inventory, land, and equipment, that have fair values
of $200,000, $25,000 and $35,000, respectively. Sanderson has patent rights valued at $10,000.
Required:
A. Prepare Peterson’s general journal entry for the cash purchase of Sanderson’s net assets.
B. Assume Peterson Corporation purchased the net assets of Sanderson Corporation for $160,000
rather than $280,000, prepare the general journal entry.
2-3 Pate Company acquired the assets (except cash) and assumed the liabilities of Sand Company on
January 1, 2004, paying $1,200,000 cash. Immediately prior to the acquisition, Sand Company’s
balance sheet was as follows:
BOOK VALUE FAIR VALUE
Accounts receivable (net) $ 120,000 $ 110,000
Inventory 145,000 160,000
Land 480,000 754,000
Buildings (net) 510,000 696,000
Total $1,255,000 $1,720,000
Accounts payable $ 135,000 $ 135,000
Note payable 300,000 300,000
Common stock, $5 par 210,000
Chapter 2 Methods of Accounting for Business Combinations 2-7
Other contributed capital 320,000
Retained earnings 290,000
Total $1,255,000
Pate Company agreed to pay Sand Company’s former stockholders $100,000 cash if postcombination earnings of the combined company reached $500,000 during 2004.
Required:
A. Prepare the journal entry necessary for Pate Company to record the acquisition on January 1,
2004.
B. Prepare the journal entry necessary for Pate Company to settle the earnings contingency,
assuming the contingent payment was $70,000 instead of $100,000.
2-4 Condensed balance sheets for Poole Company and Simon Company on January 1, 2004 are as
follows:
Poole Simon
Current Assets $ 290,000 $135,000
Plant and Equipment (net) 720,000 225,000
Total Assets $1,010,000 $360,000
Total Liabilities $ 150,000 $ 55,000
Common Stock, $10 par value 560,000 160,000
Other Contributed Capital 200,000 85,000
Retained Earnings 100,000 60,000
Total Equities $1,010,000 $360,000
On January 1, 2004 the stockholders of Poole and Simon agreed to a consolidation whereby a new
corporation, Lawson Company, would be formed to consolidate Poole and Simon. Lawson
Company issued 50,000 shares of its $20 par value common stock for the net assets of Poole and
Simon. On the date of consolidation, the fair values of Poole’s and Simon’s current assets and
liabilities were equal to their book values. The fair value of plant and equipment for each company
was: Poole, $850,000; Simon, $240,000.
An investment banking house estimated that the fair value of Lawson Company’s common stock
was $35 per share. Poole will incur $30,000 of direct acquisition costs and $10,000 in stock issue
costs.
Required:
Prepare the journal entries to record the consolidation on the books of Lawson Company assuming
that:
A. The consolidation is accounted for as a purchase.
B. The consolidation is accounted for as a pooling of interests.
2-8 Chapter 2 Methods of Accounting for Business Combinations
2-5 The stockholders’ equities of P Corporation and S Corporation were as follows on January 1, 2004:
P Corp. S Corp.
Common Stock, $1 par $2,000,000 $ 600,000
Other Contributed Capital 5,500,000 1,100,000
Retained Earnings 1,300,000 340,000
Total Stockholders’ equity $8,800,000 $2,040,000
On January 2, 2004 P Corp. issued 200,000 of its shares with a market value of $14 per share in
exchange for all of S’s shares, and S Corp. was dissolved. P Corp. paid $20,000 to register and
issue the new common shares.
Required:
A. Prepare the stockholders’ equity section of P Corp. balance after the business combination on
January 2, 2004.
2-6 The managers of Petty Company own 5,000 of its 50,000 outstanding common shares. Swann
Company is formed by the managers of Petty Company to take over Petty Company in a leveraged
buyout. The managers contribute their shares in Petty Company and Swann Company then borrows
$225,000 to purchase the remaining 45,000 shares of Petty Company for $200,000; the remaining
$25,000 is used for working capital. Petty Company is then merged into Swann Company effective
January 1, 2004. Data relevant to Petty Company immediately prior to the leveraged buyout follow:
Book Value Fair Value
Current Assets $ 30,000 $ 30,000
Plant Assets 85,000 175,000
Liabilities (15,000) (15,000)
Stockholders’ Equity $100,000 $190,000
Required:
A. Prepare journal entries on Swann Company’s books to reflect the effects of the leveraged
buyout.
B. Determine the balance of each of the following immediately after the merger:
1. Current Assets
2. Plant Assets
3. Note Payable
4. Common Stock
Chapter 2 Methods of Accounting for Business Combinations 2-9
From the Jeter 2e Study Guide:
2-7
Proust Corporation is considering a merger with Seville Company. After considerable negotiations, the
two companies determined that two shares of each Seville Company stock would be replaced with one
share of Proust stock. The balance sheets of the two companies are below, along with the fair value of
Seville’s identifiable net assets. At this time, Proust’s stock is selling for $50 a share, and Seville’s
stock is selling for $25.
Seville’s
___Proust Seville Fair Values
$ 30,000 $ 30,000
Cash $ 50,000 $ 30,000 $ 30,000
Receivables 20,000 15,000 14,000
Inventories 15,000 20,000 23,000
Plant and equipment (net) 150,000 80,000 95,000
Total assets $ 235,000 $ 145,000
Liabilities $ 25,000 $ 10,000 $ 10,000
Common Stock, $10 par 100,000 75,000
Other cont. capital 50,000 20,000
Retained earnings 60,000 40,000
Total equities $ 235,000 $ 145,000
Required:
A. Assume the merger will be accounted for as a purchase. Determine the value of the stock issued and
the resulting cost of the merger to Proust. Determine any goodwill.
B. Prepare journal entries for the Proust Company after the merger.
2-10 Chapter 2 Methods of Accounting for Business Combinations
ANSWER KEY
Multiple Choice
1. b
2. a
3. d
4. d
5. b
6. b
7. c
8. b
9. d
10. b
11. c
12. c
13. d
14. a
15. d
16. c
17. d
18. a
19. d
20. c
21. b
22. c
23. a
24. b
25. c
26. c
27. d
Problems
2-1 A. FMV of shares issued by Paul (20,000sh x $28.00) = $560,000
Finder’s fees 10,000
Legal and accounting fees 6,000
Total investment cost $576,000
B. Investment cost from Part A $576,000
Less:Fair value of Steve’s net assets ($680,000+$50,000-$300,000) 430,000
Goodwill from investment $146,000
2-2 A. Accounts Receivable 90,000
Inventory 200,000
Land 25,000
Building 30,000
Equipment 35,000
Patent 10,000
Goodwill 15,000
Current Liabilities 35,000
Long-term Debt 80,000
Cash 290,000
B. Accounts Receivable 90,000
Inventory 200,000
Current Liabilities 35,000
Long-term Debt 80,000
Cash 170,000
Extraordinary Gain 5,000
2-3 A. Accounts Receivable 120,000
Inventory 160,000
Land ($754,000 – $44,200) 709,800
Buildings ($696,000 – $40,800) 655,200
Allowance for Uncollectible Accounts 10,000
Accounts Payable 135,000
Chapter 2 Methods of Accounting for Business Combinations 2-11
Note Payable 300,000
Cash 1,200,000
Cost of acquisition $1,200,000
Fair value of net assets acquired
($1,720,000 – $435,000) 1,285,000
Excess of fair value over cost $ 85,000
Allocation of excess of fair value over cost:
Land 754,000/1,450,000 = 52% × $85,000 = $44,200
Buildings 696,000/1,450,000 = 48% × 85,000 = 40,800
$85,000
B. Land (52% × $70,000) 36,400
Buildings (48% × $70,000) 33,600
Cash 70,000
2-4 A. Current Assets ($290 + $135) 425,000
Plant and Equipment ($850 + $240) 1,090,000
Goodwill 440,000
Liabilities ($150 + $55) 205,000
Common Stock
(50,000 shares @ $20/share) 1,000,000
Other Contributed Capital
(50,000 × ($35-$20)) 750,000
Goodwill 30,000
Cash 30,000
Other Contributed Capital 10,000
Cash 10,000
B. Current Assets ($290 + $135) 425,000
Plant and Equipment ($720 + $225) 945,000
Liabilities ($150 + $55) 205,000
Common Stock
(50,000 shares @ $20/share) 1,000,000
Other Contributed Capital
($200 + $85 – $280) 5,000
Retained Earnings ($100 + $60) 160,000
Miscellaneous Expense 40,000
Cash 40,000
2-5 A. Stockholders’ Equity:
Common Stock, $1 par $2,200,000
Other Contributed Capital 8,080,000 [$5,500,000 + (200,000 X $13) – $20,000]
Retained Earnings 1,300,000
Total stockholders’ Equity $11,580,000
2-12 Chapter 2 Methods of Accounting for Business Combinations
2-6
Part A
Investment in Petty Company ($100,000 X .10) 10,000
Common Stock 10,000
Cash 225,000
Note Payable 225,000
Investment in Petty Company 200,000
Cash 200,000
Current Assets 30,000
Plant Assets (1) 166,000
Goodwill (2) 29,000
Liabilities 15,000
Investment in Petty 210,000
(1) $85,000 + [.90 × ($175,000 – $85,000)] = $166,000
(2) Cost of shares $200,000
Book value of net assets (.90 x $100,000) = 90,000
Difference between cost and book value $110,000
Allocated to:
Plant assets (.90 x ($175,000 – $85,000)) = 81,000
Goodwill 29,000
Part B
1. Current Assets ($30,000 + $25,000) 55,000
2. Plant Assets ($85,000 + $81,000) 166,000
3. Note Payable 225,000
4. Common Stock 10,000
Chapter 2 Methods of Accounting for Business Combinations 2-13
2-7
A. Seville’s net assets at fair value:
Cash $ 30,000
Receivables 14,000
Inventory 23,000
Plant & Equip 95,000
Total assets $162,000
Liabilities 10,000
Fair value of S’s net assets $152,000
Proust’s stock issued:
Seville’s stock = $75,000/$10 par value = 7,500 shares
Proust issues 7,500/2 = 3,750 new shares x $50 market price = $187,500
Goodwill:
Proust’s cost $187,500
Fair value of S’s assets 152,000
Goodwill $ 35,500
