,Solution Manual & Test Bank for Advanced
Accounting, 7th Edition by Debra C. Jeter
CHAPTER 1
ANSWERS TO QUESTIONS
1. Internal expansion involves a normal increase in business resulting from increased demand for products
and services, achieved without acquisition of preexisting firms. Some companies expand internally by
undertaking new product research to expand their total market, or by attempting to obtain a greater
share of a given market through advertising and other promotional activities. Marketing can also be
expanded into new geographical areas.
External expansion is the bringing together of two or more firms under common control by acquisition.
Referred to as business combinations, these combined operations may be integrated, or each firm may
be left to operate intact.
2. Four advantages of business combinations as compared to internal expansion are:
(1) Management is provided with an established operating unit with its own experienced personnel,
regular suppliers, productive facilities and distribution channels.
(2) Expanding by combination does not create new competition.
(3) Permits rapid diversification into new markets.
(4) Income tax benefits.
3. The primary legal constraint on business combinations is that of possible antitrust suits. The United
States government is opposed to the concentration of economic power that may result from business
combinations and has enacted two federal statutes, the Sherman Act and the Clayton Act to deal with
antitrust problems.
4. (1) A horizontal combination involves companies within the same industry that have previously
been competitors.
(2) Vertical combinations involve a company and its suppliers and/or customers.
(3) Conglomerate combinations involve companies in unrelated industries having little production
or market similarities.
5. A statutory merger results when one company acquires all of the net assets of one or more other
companies through an exchange of stock, payment of cash or property, or the issue of debt instruments.
The acquiring company remains as the only legal entity, and the acquired company ceases to exist or
remains as a separate division of the acquiring company.
A statutory consolidation results when a new corporation is formed to acquire two or more corporations,
through an exchange of voting stock, with the acquired corporations ceasing to exist as separate legal
entities.
A stock acquisition occurs when one corporation issues stock or debt or pays cash for all or part of the
voting stock of another company. The stock may be acquired through market purchases or through
direct purchase from or exchange with individual stockholders of the investee or subsidiary company.
6. A tender offer is an open offer to purchase up to a stated number of shares of a given corporation at a
stipulated price per share. The offering price is generally set above the current market price of the
shares to offer an additional incentive to the prospective sellers.
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,7. A stock exchange ratio is generally expressed as the number of shares of the acquiring company that
are to be exchanged for each share of the acquired company.
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, 8. Defensive tactics include:
(1) Poison pill – when stock rights are issued to existing stockholders that enable them to purchase
additional shares at a price below market value, but exercisable only in the event of a potential takeover.
This tactic is effective in some cases.
(2) Greenmail – when the shares held by a would-be acquiring firm are purchased at an amount
substantially in excess of their fair value. The shares are then usually held in treasury. This tactic is
generally ineffective.
(3) White knight or white squire – when a third firm more acceptable to the target company
management is encouraged to acquire or merge with the target firm.
(4) Pac-man defense – when the target firm attempts an unfriendly takeover of the would-be acquiring
company.
(5) Selling the crown jewels – when the target firms sells valuable assets to others to make the firm less
attractive to an acquirer.
9. In an asset acquisition, the firm must acquire 100% of the assets of the other firm, while in a stock
acquisition, a firm may gain control by purchasing 50% or more of the voting stock. Also, in a stock
acquisition, formal negotiations with the target’s management can sometimes be avoided. Further, in a
stock acquisition, there might be advantages in keeping the firms as separate legal entities such as for
tax purposes.
10. Does the merger increase or decrease expected earnings performance of the acquiring institution?
From a financial and shareholder perspective, the price paid for a firm is hard to justify if earnings per
share declines. When this happens, the acquisition is considered dilutive. Conversely, if the earnings
per share increases as a result of the acquisition, it is referred to as an accretive acquisition.
11. Under the parent company concept, the writeup or writedown of the net assets of the subsidiary in
the consolidated financial statements is restricted to the amount by which the cost of the investment
is more or less than the book value of the net assets acquired. Noncontrolling interest in net assets is
unaffected by such writeups or writedowns.
The economic unit concept supports the writeup or writedown of the net assets of the subsidiary by
an amount equal to the entire difference between the fair value and the book value of the net assets
on the date of acquisition. In this case, noncontrolling interest in consolidated net assets is adjusted
for its share of the writeup or writedown of the net assets of the subsidiary.
12. a) Under the parent company concept, noncontrolling interest is considered a liability of the
consolidated entity whereas under the economic unit concept, noncontrolling interest is
considered a separate equity interest in consolidated net assets.
b) The parent company concept supports partial elimination of intercompany profit whereas the
economic unit concept supports 100 percent elimination of intercompany profit.
c) The parent company concept supports valuation of subsidiary net assets in the consolidated
financial statements at book value plus an amount equal to the parent company’s percentage
interest in the difference between fair value and book value. The economic unit concept supports
valuation of subsidiary net assets in the consolidated financial statements at their fair value on the
date of acquisition without regard to the parent company’s percentage ownership interest.
d) Under the parent company concept, consolidated net income measures the interest of the
shareholders of the parent company in the operating results of the consolidated entity. Under the
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Accounting, 7th Edition by Debra C. Jeter
CHAPTER 1
ANSWERS TO QUESTIONS
1. Internal expansion involves a normal increase in business resulting from increased demand for products
and services, achieved without acquisition of preexisting firms. Some companies expand internally by
undertaking new product research to expand their total market, or by attempting to obtain a greater
share of a given market through advertising and other promotional activities. Marketing can also be
expanded into new geographical areas.
External expansion is the bringing together of two or more firms under common control by acquisition.
Referred to as business combinations, these combined operations may be integrated, or each firm may
be left to operate intact.
2. Four advantages of business combinations as compared to internal expansion are:
(1) Management is provided with an established operating unit with its own experienced personnel,
regular suppliers, productive facilities and distribution channels.
(2) Expanding by combination does not create new competition.
(3) Permits rapid diversification into new markets.
(4) Income tax benefits.
3. The primary legal constraint on business combinations is that of possible antitrust suits. The United
States government is opposed to the concentration of economic power that may result from business
combinations and has enacted two federal statutes, the Sherman Act and the Clayton Act to deal with
antitrust problems.
4. (1) A horizontal combination involves companies within the same industry that have previously
been competitors.
(2) Vertical combinations involve a company and its suppliers and/or customers.
(3) Conglomerate combinations involve companies in unrelated industries having little production
or market similarities.
5. A statutory merger results when one company acquires all of the net assets of one or more other
companies through an exchange of stock, payment of cash or property, or the issue of debt instruments.
The acquiring company remains as the only legal entity, and the acquired company ceases to exist or
remains as a separate division of the acquiring company.
A statutory consolidation results when a new corporation is formed to acquire two or more corporations,
through an exchange of voting stock, with the acquired corporations ceasing to exist as separate legal
entities.
A stock acquisition occurs when one corporation issues stock or debt or pays cash for all or part of the
voting stock of another company. The stock may be acquired through market purchases or through
direct purchase from or exchange with individual stockholders of the investee or subsidiary company.
6. A tender offer is an open offer to purchase up to a stated number of shares of a given corporation at a
stipulated price per share. The offering price is generally set above the current market price of the
shares to offer an additional incentive to the prospective sellers.
1-1
,7. A stock exchange ratio is generally expressed as the number of shares of the acquiring company that
are to be exchanged for each share of the acquired company.
1-2
, 8. Defensive tactics include:
(1) Poison pill – when stock rights are issued to existing stockholders that enable them to purchase
additional shares at a price below market value, but exercisable only in the event of a potential takeover.
This tactic is effective in some cases.
(2) Greenmail – when the shares held by a would-be acquiring firm are purchased at an amount
substantially in excess of their fair value. The shares are then usually held in treasury. This tactic is
generally ineffective.
(3) White knight or white squire – when a third firm more acceptable to the target company
management is encouraged to acquire or merge with the target firm.
(4) Pac-man defense – when the target firm attempts an unfriendly takeover of the would-be acquiring
company.
(5) Selling the crown jewels – when the target firms sells valuable assets to others to make the firm less
attractive to an acquirer.
9. In an asset acquisition, the firm must acquire 100% of the assets of the other firm, while in a stock
acquisition, a firm may gain control by purchasing 50% or more of the voting stock. Also, in a stock
acquisition, formal negotiations with the target’s management can sometimes be avoided. Further, in a
stock acquisition, there might be advantages in keeping the firms as separate legal entities such as for
tax purposes.
10. Does the merger increase or decrease expected earnings performance of the acquiring institution?
From a financial and shareholder perspective, the price paid for a firm is hard to justify if earnings per
share declines. When this happens, the acquisition is considered dilutive. Conversely, if the earnings
per share increases as a result of the acquisition, it is referred to as an accretive acquisition.
11. Under the parent company concept, the writeup or writedown of the net assets of the subsidiary in
the consolidated financial statements is restricted to the amount by which the cost of the investment
is more or less than the book value of the net assets acquired. Noncontrolling interest in net assets is
unaffected by such writeups or writedowns.
The economic unit concept supports the writeup or writedown of the net assets of the subsidiary by
an amount equal to the entire difference between the fair value and the book value of the net assets
on the date of acquisition. In this case, noncontrolling interest in consolidated net assets is adjusted
for its share of the writeup or writedown of the net assets of the subsidiary.
12. a) Under the parent company concept, noncontrolling interest is considered a liability of the
consolidated entity whereas under the economic unit concept, noncontrolling interest is
considered a separate equity interest in consolidated net assets.
b) The parent company concept supports partial elimination of intercompany profit whereas the
economic unit concept supports 100 percent elimination of intercompany profit.
c) The parent company concept supports valuation of subsidiary net assets in the consolidated
financial statements at book value plus an amount equal to the parent company’s percentage
interest in the difference between fair value and book value. The economic unit concept supports
valuation of subsidiary net assets in the consolidated financial statements at their fair value on the
date of acquisition without regard to the parent company’s percentage ownership interest.
d) Under the parent company concept, consolidated net income measures the interest of the
shareholders of the parent company in the operating results of the consolidated entity. Under the
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