Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities
CHAPTER 1
INTERCORPORATE ACQUISITIONS AND INVESTMENTS IN OTHER ENTITIES
ANSWERS TO QUESTIONS
Q1-1 Complex organizational structures often result when companies do business in a
complex business environment. New subsidiaries or other entities may be formed for purposes
such as extending operations into foreign countries, seeking to protect existing assets from risks
associated with entry into new product lines, separating activities that fall under regulatory
controls, and reducing taxes by separating certain types of operations.
Q1-2 The split-off and spin-off result in the same reduction of reported assets and liabilities.
Only the stockholders’ equity accounts of the company are different. The number of shares
outstanding remains unchanged in the case of a spin-off and retained earnings or paid-in capital
is reduced. Shares of the parent are exchanged for shares of the subsidiary in a split-off,
thereby reducing the outstanding shares of the parent company.
Q1-3 Enron’s management used special-purpose entities to avoid reporting debt on its balance
sheet and to create fictional transactions that resulted in reported income. It also transferred bad
loans and investments to special-purpose entities to avoid recognizing losses in its income
statement.
Q1-4 (a) A statutory merger occurs when one company acquires another company and the
assets and liabilities of the acquired company are transferred to the acquiring company; the
acquired company is liquidated, and only the acquiring company remains. The acquiring
company can give cash or other assets in addition to stock.
(b) A statutory consolidation occurs when a new company is formed to acquire the assets
and liabilities of two combining companies. The combining companies dissolve, and the new
company is the only surviving entity.
(c) A stock acquisition occurs when one company acquires a majority of the common stock of
another company and the acquired company is not liquidated; both companies remain as
separate but related corporations.
Q1-5 A noncontrolling interest exists when the acquiring company gains control but does not
own all the shares of the acquired company. The non-controlling interest is made up of the
shares not owned by the acquiring company.
Q1-6 Goodwill is the excess of the sum of (1) the fair value given by the acquiring company,
(2) the fair value of any shares already owned by the parent and (3) the acquisition-date fair
value of any noncontrolling interest over the acquisition-date fair value of the net identifiable
assets acquired in the business combination.
Q1-7 A differential is the total difference at the acquisition date between the sum of (1) the fair
value given by the acquiring company, (2) the fair value of any shares already owned by the
parent and (3) the acquisition-date fair value of any noncontrolling interest and the book value of
the net identifiable assets acquired is referred to as the differential.
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, Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities
Q1-8 The purchase of a company is viewed in the same way as any other purchase of assets.
The acquired company is owned by the acquiring company only for the portion of the year
subsequent to the combination. Therefore, earnings are accrued only from the date of purchase
forward.
Q1-9 None of the retained earnings of the subsidiary should be carried forward under the
acquisition method. Thus, consolidated retained earnings immediately following an acquisition is
limited to the balance reported by the acquiring company.
Q1-10 Additional paid-in capital reported following a business combination is the amount
previously reported on the acquiring company's books plus the excess of the fair value over the
par or stated value of any shares issued by the acquiring company in completing the acquisition
less any sock issue costs.
Q1-11 When the acquisition method is used, all costs incurred in bringing about the
combination are expensed as incurred. None are capitalized. However, costs associated with
the issuance of stock are recorded as a reduction of additional paid-in capital.
Q1-12 When the acquiring company issues shares of stock to complete a business
combination, the excess of the fair value of the stock issued over its par value is recorded as
additional paid-in capital. All costs incurred by the acquiring company in issuing the securities
should be treated as a reduction in the additional paid-in capital. Items such as audit fees
associated with the registration of the new securities, listing fees, and brokers' commissions
should be treated as reductions of additional paid-in capital when stock is issued.
Q1-13 If the fair value of a reporting unit acquired in a business combination exceeds its
carrying amount, the goodwill of that reporting unit is considered unimpaired. On the other hand,
if the carrying amount of the reporting unit exceeds its fair value, impairment of goodwill is
implied. An impairment must be recognized if the carrying amount of the goodwill assigned to
the reporting unit is greater than the implied value of the carrying unit’s goodwill. The implied
value of the reporting unit’s goodwill is determined as the excess of the fair value of the
reporting unit over the fair value of its net identifiable assets.
Q1-14 A bargain purchase occurs when the fair value of the consideration given in a business
combination, along with the fair value of any equity interest in the acquiree already held and the
fair value of any noncontrolling interest in the acquiree, is less than the fair value of the
acquiree’s net identifiable assets.
Q1-15 The acquirer should record the clarification of the acquisition-date fair value of buildings
as a reduction to buildings and addition to goodwill.
.
Q1-16 The acquirer must revalue the equity position to its fair value at the acquisition date and
recognize a gain. A total of $250,000 ($25 x 10,000 shares) would be recognized in this case
assuming that the $65 per share price is the appropriate fair value for all shares (i.e. there is no
control premium for the new shares purchased).
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CHAPTER 1
INTERCORPORATE ACQUISITIONS AND INVESTMENTS IN OTHER ENTITIES
ANSWERS TO QUESTIONS
Q1-1 Complex organizational structures often result when companies do business in a
complex business environment. New subsidiaries or other entities may be formed for purposes
such as extending operations into foreign countries, seeking to protect existing assets from risks
associated with entry into new product lines, separating activities that fall under regulatory
controls, and reducing taxes by separating certain types of operations.
Q1-2 The split-off and spin-off result in the same reduction of reported assets and liabilities.
Only the stockholders’ equity accounts of the company are different. The number of shares
outstanding remains unchanged in the case of a spin-off and retained earnings or paid-in capital
is reduced. Shares of the parent are exchanged for shares of the subsidiary in a split-off,
thereby reducing the outstanding shares of the parent company.
Q1-3 Enron’s management used special-purpose entities to avoid reporting debt on its balance
sheet and to create fictional transactions that resulted in reported income. It also transferred bad
loans and investments to special-purpose entities to avoid recognizing losses in its income
statement.
Q1-4 (a) A statutory merger occurs when one company acquires another company and the
assets and liabilities of the acquired company are transferred to the acquiring company; the
acquired company is liquidated, and only the acquiring company remains. The acquiring
company can give cash or other assets in addition to stock.
(b) A statutory consolidation occurs when a new company is formed to acquire the assets
and liabilities of two combining companies. The combining companies dissolve, and the new
company is the only surviving entity.
(c) A stock acquisition occurs when one company acquires a majority of the common stock of
another company and the acquired company is not liquidated; both companies remain as
separate but related corporations.
Q1-5 A noncontrolling interest exists when the acquiring company gains control but does not
own all the shares of the acquired company. The non-controlling interest is made up of the
shares not owned by the acquiring company.
Q1-6 Goodwill is the excess of the sum of (1) the fair value given by the acquiring company,
(2) the fair value of any shares already owned by the parent and (3) the acquisition-date fair
value of any noncontrolling interest over the acquisition-date fair value of the net identifiable
assets acquired in the business combination.
Q1-7 A differential is the total difference at the acquisition date between the sum of (1) the fair
value given by the acquiring company, (2) the fair value of any shares already owned by the
parent and (3) the acquisition-date fair value of any noncontrolling interest and the book value of
the net identifiable assets acquired is referred to as the differential.
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, Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities
Q1-8 The purchase of a company is viewed in the same way as any other purchase of assets.
The acquired company is owned by the acquiring company only for the portion of the year
subsequent to the combination. Therefore, earnings are accrued only from the date of purchase
forward.
Q1-9 None of the retained earnings of the subsidiary should be carried forward under the
acquisition method. Thus, consolidated retained earnings immediately following an acquisition is
limited to the balance reported by the acquiring company.
Q1-10 Additional paid-in capital reported following a business combination is the amount
previously reported on the acquiring company's books plus the excess of the fair value over the
par or stated value of any shares issued by the acquiring company in completing the acquisition
less any sock issue costs.
Q1-11 When the acquisition method is used, all costs incurred in bringing about the
combination are expensed as incurred. None are capitalized. However, costs associated with
the issuance of stock are recorded as a reduction of additional paid-in capital.
Q1-12 When the acquiring company issues shares of stock to complete a business
combination, the excess of the fair value of the stock issued over its par value is recorded as
additional paid-in capital. All costs incurred by the acquiring company in issuing the securities
should be treated as a reduction in the additional paid-in capital. Items such as audit fees
associated with the registration of the new securities, listing fees, and brokers' commissions
should be treated as reductions of additional paid-in capital when stock is issued.
Q1-13 If the fair value of a reporting unit acquired in a business combination exceeds its
carrying amount, the goodwill of that reporting unit is considered unimpaired. On the other hand,
if the carrying amount of the reporting unit exceeds its fair value, impairment of goodwill is
implied. An impairment must be recognized if the carrying amount of the goodwill assigned to
the reporting unit is greater than the implied value of the carrying unit’s goodwill. The implied
value of the reporting unit’s goodwill is determined as the excess of the fair value of the
reporting unit over the fair value of its net identifiable assets.
Q1-14 A bargain purchase occurs when the fair value of the consideration given in a business
combination, along with the fair value of any equity interest in the acquiree already held and the
fair value of any noncontrolling interest in the acquiree, is less than the fair value of the
acquiree’s net identifiable assets.
Q1-15 The acquirer should record the clarification of the acquisition-date fair value of buildings
as a reduction to buildings and addition to goodwill.
.
Q1-16 The acquirer must revalue the equity position to its fair value at the acquisition date and
recognize a gain. A total of $250,000 ($25 x 10,000 shares) would be recognized in this case
assuming that the $65 per share price is the appropriate fair value for all shares (i.e. there is no
control premium for the new shares purchased).
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