978-0078025877 Chapter 1 Solution Manual Part 1

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

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

Q1-3 The management of Enron appears to have used special-purpose entities to avoid

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.

Q1-5 A noncontrolling interest exists when the acquiring company gains control but does not

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

Q1-7 The level of ownership acquired does not impact the amount of goodwill reported under

Q1-8 The total difference at the acquisition date between the sum of (1) the fair value given by

Q1-9 The purchase of a company is viewed in the same way as any other purchase of assets.

forward.

Q1-10 None of the retained earnings of the subsidiary should be carried forward under the

Q1-11 Additional paid-in capital reported following a business combination is the amount

Q1-12 When the acquisition method is used, all costs incurred in bringing about the

Q1-13 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

Q1-14 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,

Q1-15 When the fair value of the consideration given in a business combination, along with the

Q1-16 The acquirer should record the clarification of the acquisition-date fair value of buildings

.

Q1-17 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

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

SOLUTIONS TO CASES

C1-1 Assignment of Acquisition Costs

MEMO

To: Vice-President of Finance

Troy Company

From: , CPA

Re: Recording Acquisition Costs of Business Combination

C1-2 Evaluation of Merger

Page numbers refer to the page in the 3M 2005 10-K report.

a. The CUNO acquisition improved 3M’s product mix by adding a comprehensive line of filtration

c. Two of major factors appear to have had a significant influence on the merger movement in

the mid-2000s. First, interest rates were very low during that time, and a great amount of

unemployed cash was available worldwide. Many business combinations were effected through

significant borrowing. Second, private equity funds pooled money from various institutional

investors and wealthy individuals and used much of it to acquire companies.

many mergers result in companies that are more efficient and can compete better in a global

economy; this in turn may result in more jobs and lower prices. Even if corporate mergers are

viewed favorably, however, the question arises as to whether the government, and ultimately

the taxpayers, should be subsidizing those mergers through tax incentives. Many would argue

that the desirability of individual corporate mergers, along with other types of investment

and timely and would not influence the economic decisions being reported. Any change in

reporting requirements that would increase or decrease management’s ability to “manage”

earnings could impact management’s willingness to enter new or risky business fields and affect

the level of business combinations. Greater flexibility in determining which subsidiaries are to be

consolidated, the way in which intercorporate income is calculated, the elimination of profits on

C1-4 Determination of Goodwill Impairment

MEMO

TO: Chief Accountant

Plush Corporation

From: , CPA

Re: Determining Impairment of Goodwill

considered to be impaired. If the fair value is less than the carrying value, a second test must be

performed. An impairment loss must be reported if the carrying amount of reporting unit goodwill

exceeds the implied fair value of that goodwill. [ASC 350-20–35–11]

At the date of acquisition, Plush Corporation recognized goodwill of $20,000 ($450,000 –

$430,000) and assigned it to a single reporting unit. Even though the fair value of the reporting

ASC 350-20–35–11

ASC 350-20–35–30

ASC 350-20–35–41

C1-5 Risks Associated with Acquisitions

Google discloses on page 21 of its 2006 Form 10-K that it does not have significant experience

acquiring companies. It also notes that most acquisitions the company has already completed

have been small companies. The specific risk areas identified include:

C1-6 Numbers Game

a. A company is motivated to keep its stock price high. However, stock price is very sensitive to

information about company performance. When the company reports lower earnings than the

market anticipated, the stock price often falls significantly. A desire to increase reported

C1-7 MCI: A Succession of Mergers

The story of MCI WorldCom (later, MCI) is the story of the man who is largely responsible for

both the rise and fall of MCI WorldCom. Bernard Ebbers was Chief Executive Officer of MCI

until he resigned under pressure from the Board of Directors in April 2002. He put together over

five dozen acquisitions in the two decades prior to stepping down. In 1983, he and three friends

Telecommunications Group. Later in 1995, the company changed its name to WorldCom, Inc. In

1996, WorldCom acquired the large Internet services provider UUNET by merging with its

parent company, MFS Communications Company, in an exchange of stock. In 1997, WorldCom

purchased the Internet and networking divisions of America Online and CompuServe in a three–

way stock and asset swap. In 1998, the Company acquired MCI Communications Corporation

additional inappropriate accounting activities and restatements of financial statements further

blemished the company’s reputation. In April 2003, WorldCom filed a plan of reorganization with

the SEC and changed the company name from WorldCom to MCI. The company went through

a period of retrenchment, and in early 2006 merged with Verizon Communications. Thus, MCI is

no longer a separate company but rather is part of Verizon’s wireline business.

C1-8 Leveraged Buyouts

a. A leveraged buyout (LBO) involves acquiring a company in a transaction or series of planned

transactions that include using a very high proportion of debt, often secured by the assets of the

target company. Normally, the investors acquire all of the stock or assets of the target company.

A management buyout (MBO) occurs when the existing management of a company acquires all

structure of the buyout. The FASB has not taken a position on whether an LBO is a type of

business combination. The EITF indicated that LBOs of the type it was considering are similar to

business combinations. Most LBOs are effected by establishing a holding company for the

purpose of acquiring the assets or stock of the target company. Such a holding company has no

substantive operations. Some would argue that a business combination can occur only if the

Chapter 01 – Intercorporate Acquisitions and Investments in Other Entities

SOLUTIONS TO EXERCISES

E1-1 Multiple-Choice Questions on Complex Organizations

1. b – As companies grow in size and respond to their unique business environment, they often

develop complex organizational and ownership structures.

(a) Incorrect. The need to avoid legal liability is not a direct result of increased complexity.

(c) Incorrect. Part of the reason the business environment is complex is due to the

increased number and type of divisions and product lines in companies.

(d) Incorrect. This statement is false. There has been an impact on organizational

structure and management.