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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.
