ELECTRONIC SUPPLEMENT TO CHAPTER 1

Transcription

1 C H A P T E R 1 ELECTRONIC SUPPLEMENT TO CHAPTER 1 POOLING OF INTERESTS ACCOUNTING The issuance of FASB Statement No. 141 makes pooling of interests accounting for business combinations a thing of the past under U.S. GAAP. No new pooling combinations will be recorded unless initiated by June 30, Many of the detailed issues related to poolings concern the original recording of the combination. Since there will be no new poolings, this material is considerably less important than it was at the writing of the prior edition of this text. The information in this electronic supplement to Chapter 1 is primarily related to the initial recording of poolings. Again, grandfathering of prior poolings makes it useful to understand the recording of past poolings, but you will not need this accounting detail for transactions that will not recur in the future. Conditions for Pooling The pooling of interests concept was based on the assumption that it was possible to unite ownership interests through the exchange of equity securities without an acquisition of one combining company by another. 1 Accordingly, application of the concept was limited to those business combinations in which the combining entities exchanged equity securities and the operations and ownership interests continued in a new accounting entity. In APB Opinion No. 16, the APB sought to prevent pooling of interests accounting for business combinations that were incompatible with the pooling concept. It did this by specifying (in paragraphs 45 through 48 of Opinion No. 16) 12 conditions that had to be met for the pooling of interests method to be used. These conditions are summarized under the headings used by the APB. ATTRIBUTES OF COMBINING COMPANIES Two of the conditions for a pooling of interests were classified as attributes of the combining companies. The first condition was that each of the combining companies was autonomous and had not been a subsidiary or division of another corporation within two years before the plan of combination was initiated. The date of initiation was the earlier of the public announcement of the ratio of exchange of stock or the notification of the stockholders of the exchange ratio. The exchange ratio was the ratio of the number of shares of the issuing company s stock to be exchanged for each share of the other combining company s stock on the date of consummation of the pooling. 1 The underlying assumptions of pooling had been challenged by many writers in accounting. For example, see Accounting Research Study No. 5. A Critical Study of Accounting for Business Combinations, by Arthur R. Wyatt (New York: American Institute of Certified Public Accountants, 1963). Electronic Supplement to Chapter 1 1

2 The second condition was that each of the combining companies be independent of the others. This was interpreted to mean that the other combining companies together owned no more than 10% of the voting stock of any combining company. MANNER OF COMBINING INTERESTS There were seven conditions for pooling. First, the combination must have been effected in a single transaction or been completed in accordance with a specific plan within one year after the plan was initiated. Failure to meet the one-year requirement did not prevent the pooling treatment if consummation was delayed by lawsuits, regulatory agencies, or other factors beyond the control of management. Second, one corporation (the issuing corporation) must have offered and issued only common stock in exchange for substantially all (90% or more) of the outstanding voting stock of another company (a combining company) on the date the plan was consummated. The number of shares assumed to be exchanged excluded shares of the combining company held by the issuing company when the plan was initiated, shares acquired by the issuing company before the plan was consummated, and shares outstanding after the plan was consummated. If the combining company held shares in the issuing company, these shares required conversion into an equivalent number of shares of the combining company and we deducted them from outstanding shares to determine the number of shares assumed to be exchanged. The reason for this adjustment was that part of the shares issued by the issuing company were used to reacquire its own shares. Such shares were not issued to acquire stock of the other combining company. 2 The third condition for pooling was that none of the combining companies changed the equity interest of the voting common stock in contemplation of effecting the combination within two years before initiation of the plan of combination or between the dates of initiation and consummation. A fourth condition was that each of the combining companies reacquired shares of voting common stock only for purposes other than business combination, and that no company reacquired more than a normal number of shares between the dates the plan was initiated and consummated. This restriction on treasury stock transactions generally did not apply to shares purchased for stock option or compensation plans. The fifth condition required that the proportionate interest of each individual common stockholder in each of the combining companies remain the same as a result of the exchange of stock to effect the combination. For example, if Stockholder A held 100 shares in the other combining company and Stockholder B held 200 shares, then Stockholder B s interest in the pooled entity must have been twice that of A s for the combination to be a pooling of interests. Condition 6 specified that the voting rights in the combined corporation be immediately exercisable by the stockholders. The final condition required resolution of the combination on the date of consummation, with no provisions pending that related to the issue of securities or other considerations. ABSENCE OF PLANNED TRANSACTIONS The last group of conditions for a pooling of interests focused on planned transactions of the combined entity. First, the combined corporation must not have retired or reacquired stock issued to effect the combination. Second, the combined corporation must not have entered into financial arrangements (such as loan guarantees) for the benefit of former stockholders of a combining company. Finally, the combined corporation must not have planned to dispose of a significant part of the assets of the combining companies within two years after the combination. Plans to dispose of assets that represented duplicate facilities were permissible. If all 12 of these conditions were met, the business combination was accounted for as a pooling of interests; otherwise, the purchase method was used. Exhibit 1 reviews the 12 conditions for a pooling of interests. Computations for the Substantially All Test Although most of the conditions for pooling are easy to understand, the second condition (the substantially all test) under the Manner of Combining Interests heading requires illustration. Assume that Pat Corporation and Sam Corporation entered into a plan of business combination on May 1, 2001, in which Pat acquired Sam s outstanding stock by issuing one share of Pat stock for 2 Paragraph 99 of Opinion No. 16 provided certain exceptions to the test of minority stock held prior to combination and the 90% substantially all test. These exceptions, commonly referred to as the grandfather clause, were intended to provide a five-year period of transition to the rules of Opinion No. 16. Although the grandfather clause initially was scheduled to expire on October 31, 1975, it was extended indefinitely by FASB Statement No ADVANCED ACCOUNTING

3 EXHIBIT 1-1 Twelve Conditions for Pooling (APB Opinion No. 16) Attributes of Combining Companies 1 Autonomous (two-year rule) 2 Independent (10% rule) Manner of Combining Interests 1 Single transaction (or completed within one year after initiation) 2 Exchange of common stock (the substantially all rule: 90% or more) 3 No equity changes in contemplation of combination (two-year rule) 4 Shares reacquired only for purposes other than combination 5 No change in proportionate equity interests 6 Voting rights immediately exercisable 7 Combination resolved at consummation (no pending provisions) Absence of Planned Transactions 1 Issuing company cannot reacquire shares 2 Issuing company cannot make deals to benefit former stockholders 3 Issuing company cannot plan to dispose of assets within two years each two shares of Sam. The agreed-upon exchange ratio was 0.5 to 1. When the plan of combination was initiated. Sam Corporation had 10,000 shares of voting common stock outstanding, of which 200 shares were already owned by Pat. After the plan of combination was initiated, Pat purchased for cash an additional 200 shares of Sam stock directly from Sam s stockholders, and Sam purchased for cash 200 shares of Pat stock from Pat s stockholders. The business combination was consummated on May 30, 2001, with Pat issuing 4,500 shares of its own stock for 9,000 shares of Sam. Sam s former stockholders continued to hold 600 shares of Sam stock. To meet the substantially all test, Pat Corporation must have issued its own stock for 90% or more of Sam s stock. Although it appears that the 90% pooling test was met, the computation shown in Exhibit 2 indicates otherwise. The Sam shares held by Pat and the Pat shares held by Sam disqualified the business combination for the pooling treatment, even though Pat issued its own stock for 90% of Sam s outstanding shares on the date of consummation of the plan. Combining Stockholders Equities in a Pooling In a pooling of interests, the recorded assets and liabilities of the separate companies became the assets and liabilities of the surviving (combined) corporation. Because total assets and liabilities equal the sum of the combining entities, so must the total equities. The capital stock of the surviving corporation must have equaled the par or stated value of outstanding shares (after the issuance of the new shares). Ordinarily, the retained earnings of the surviving corporation would have been equal to the total retained earnings of the combining companies, but this was not possible when the par or stated value of outstanding shares of the surviving entity exceeded the paid-in capital of the combining companies. If total paid-in capital of the combining companies exceeded the par or stated value of outstanding EXHIBIT 1-2 Substantially All Test for a Pooling of Interests Shares Assumed to Be Exchanged Sam s outstanding shares on May 30, ,000 Deduct: Combining company shares held by issuing company: Sam shares held by Pat on May 1, Sam shares acquired by Pat during May Equivalent number of issuing company shares held by combining company: Equivalent number of Sam shares represented by Sam s 200 shares of Pat (200/0.5 exchange ratio) 400 Sam shares outstanding after consummation 600 Sam shares assumed to be exchanged in the combination 8,600 Shares Required to Be Exchanged 10,000 outstanding shares of Sam on May 30, % 9,000 90% Test The 8,600 shares assumed exchanged was less than the required 9,000. Thus, the business combination was not a pooling of interests. Electronic Supplement to Chapter 1 3

4 shares of the surviving entity, the amount of the excess became the additional paid-in capital of the surviving entity, and the total retained earnings of the combining companies became the retained earnings of the surviving entity. Alternatively, if the par or stated value of outstanding shares of the surviving entity exceeded the total paid-in capital of the combining companies, the combined retained earnings balance was reduced by the excess, and the surviving entity had no additional paid-in capital. Recall our simple example from the appendix to Chapter 1. These relationships can be shown through a series of illustrations. Assume that immediately before their pooling of interests business combination, the stockholders equity accounts for Jake Corporation and Kate Corporation were as follows (all amounts are in thousands): Jake Kate Corporation Corporation Total Capital stock, $10 par $100 $ 50 $150 Additional paid-in capital Total paid-in capital Retained earnings Net assets and equity $160 $100 $260 In cases 1 and 2 that follow, the pooling was in the form of a merger, in which Jake Corporation was the issuing corporation and the surviving entity. In cases 3, 4, and 5, the pooling was in the form of a consolidation, and Pete Corporation was formed to take over the net assets of Jake and Kate. Jake and Kate disappeared. CASE 1: MERGER; PAID-IN CAPITAL EXCEEDS STOCK ISSUED Jake, the surviving corporation, issued 7,000 shares of its stock for the net assets of Kate. In this case, the $180,000 total paid-in capital of the combining companies exceeded the $170,000 capital stock of Jake by $10,000. As a result, Jake had capital stock of $170,000, additional paid-in capital of $10,000, and retained earnings of $80,000, for a total equity of $260,000. Observe that the net assets of the surviving entity still were equal to the total recorded assets of the combining companies. Jake recorded the pooling as follows: Net assets (+A) 100 Capital stock, $10 par (+SE) 70 Retained earnings (+SE) 30 To record issuance of 7,000 shares in a pooling with Kate Corporation. CASE 2: MERGER; STOCK ISSUED EXCEEDS PAID-IN CAPITAL Jake, the surviving entity, issued 9,000 shares of its stock for the net assets of Kate. In this case, the $190,000 capital stock of Jake exceeded the $180,000 total paid-in capital of the combining companies by $10,000. The result was that Jake would have capital stock of $190,000, no additional paid-in capital, and retained earnings of $70,000. Notice that the maximum retained earnings that can be combined ($80,000) has been reduced by the $10,000 excess of capital stock over paid-in capital. The entry on Jake s books was as follows: Net assets (+A) 100 Additional paid-in capital ( SE) 10 Capital stock $10 par (+SE) 90 Retained earnings (+SE) 20 To record issuance of 9,000 shares in a pooling with Kate Corporation. The previous cases illustrated accounting procedures for a merger accounted for as a pooling of interests. Accounting procedures for consolidation of Jake and Kate are illustrated by assuming that Pete Corporation was formed to take over the net assets of Jake and Kate Corporations. CASE 3: CONSOLIDATION; PAID-IN CAPITAL EXCEEDS STOCK ISSUED Pete Corporation issued 15,000 shares of $10 par capital stock, 10,000 to Jake and 5,000 to Kate, for their net assets. In this case, the stockholders equity of Pete, the surviving entity, was 4 ADVANCED ACCOUNTING

5 the same as for Jake Corporation in Case 1. Pete, however, opened its books with the following entry: Net assets (+A) 260 Capital stock, $10 par (+SE) 150 Additional paid-in capital (+SE) 30 Retained earnings (+SE) 80 To record issuance of 10,000 shares to Jake and 5,000 shares to Kate in a business combination accounted for as a pooling of interests. The $180,000 combined paid-in capital of Jake and Kate exceeded the $150,000 capital stock of Pete, the surviving entity, so the $30,000 excess was the additional paid-in capital of the pooled entity. Also, the $80,000 maximum retained earnings was pooled. CASE 4: CONSOLIDATION; PAID-IN CAPITAL EXCEEDS STOCK ISSUED Pete Corporation issued 17,000 shares of $10 par capital stock, 11,000 to Jake and 6,000 to Kate, for their net assets. The stockholders equity of Pete in this case was the same as Jake s stockholders equity in Case 2. Pete recorded the consolidation as follows: Net assets (+A) 260 Capital stock, $10 par (+SE) 170 Additional paid-in capital (+SE) 10 Retained earnings (+SE) 80 To record issuance of 11,000 shares to Jake and 6,000 shares to Kate in a business combination accounted for as a pooling of interests. The $180,000 total paid-in capital of the combining entities exceeded the $170,000 capital stock of Pete; therefore, the $10,000 excess was the additional paid-in capital of the pooled entity, and the $80,000 maximum retained earnings was pooled. CASE 5: CONSOLIDATION; STOCK ISSUED EXCEEDS PAID-IN CAPITAL Pete Corporation issued 19,000 shares of $10 par capital stock, 12,000 to Jake and 7,000 to Kate, for their net assets. Pete s stockholders equity in this case was the same as Jake s stockholders equity in Case 3. The entry on Pete s books to record the pooling was as follows: Net assets (+A) 260 Capital stock, $10 par (+SE) 190 Retained earnings (+SE) 70 To record issuance of 12,000 shares to Jake and 7,000 shares to Kate in a business combination accounted for as a pooling of interests. The $190,000 capital stock of Pete, the surviving entity, exceeded the $180,000 total paid-in capital of Jake and Kate, so the maximum pooled retained earnings was reduced by the $10,000 excess to $70,000, and the pooled entity had no additional paid-in capital. SUMMARY BALANCE SHEETS A summary balance sheet for the surviving entity in each of the five pooling of interests business combinations is shown in Exhibit 3. TREASURY STOCK IN A POOLING Under the provisions of APB Opinion No. 16, a corporation that distributed treasury stock in a pooling of interests would first account for those shares as retired so that their issuance would be recorded in the same manner as previously unissued stock. 3 STOCK OF ONE COMBINING COMPANY HELD BY ANOTHER COMBINING COMPANY The method of accounting for the stock of one combining company held by another combining company depends on whether the stock is stock of the surviving entity. An investment in the common stock of the surviving entity is returned to the surviving company in the combination and is treated as treasury 3 APB Opinion No. 16, paragraph 54. Electronic Supplement to Chapter 1 5

6 EXHIBIT 1-3 Summary Balance Sheets for the Five Pooling of Interests Cases Merger Jake s Books Consolidation Pete s Books Case 1 Case 2 Case 3 Case 4 Case 5 Net assets $260 $260 $260 $260 $260 Capital stock, $10 par $170 $190 $150 $170 $190 Additional paid-in capital Retained earnings Stockholders equity $260 $260 $260 $260 $260 stock of the combined entity. Alternatively, an investment by the surviving entity in another combining company is treated as stock retired as part of the combination. 4 Let us illustrate this requirement by assuming that Kam Corporation owned 200 shares of Lax Corporation common stock at the consummation of the Kam and Lax merger. Kam carried its investment in Lax account at its $3,000 cost. Summary data (in thousands) for Kam and Lax are as follows: Kam Lax Investment in Lax $ 3 Other assets 197 $300 Total $200 $300 Capital stock, $10 par $100 $200 Additional paid-in capital Retained earnings Total $200 $300 If Kam was the surviving entity and issued 19,800 shares to Lax (a 1 : 1 exchange ratio), the pooling of interests merger was recorded on Kam s books as follows: Net assets (+A) 300 Capital stock, $10 par (+SE) 198 Additional paid-in capital (+SE) 29 Retained earnings (+SE) 70 Investment in Lax ( A) 3 To record merger with Lax Corporation. If Lax was the surviving entity and issued 10,000 shares of its own stock for 10,000 shares of Kam (a 1 : 1 exchange ratio), the pooling of interests merger was recorded on the books of Lax as follows: Net assets (+A) 197 Treasury stock ( SE) 3 Capital stock, $10 par (+SE) 100 Additional paid-in capital (+SE) 50 Retained earnings (+SE) 50 To record merger with Kam Corporation. In each of these examples, the net assets of the surviving entity were $3,000 less than the recorded assets of the combining companies. The related effect on the combined stockholders equity was to reduce paid-in capital when the investment was in the combining company and to record treasury stock when the investment was in stock of the surviving entity. Expenses Related to Pooling Combinations The costs incurred to effect a business combination and to integrate the operations of the combining companies in a pooling were expenses of the combined corporation. This treatment was 4 Ibid., paragraph ADVANCED ACCOUNTING

7 EXHIBIT 1-4 Premerger Book Value and Fair Value Information COMPARATIVE TRIAL BALANCES DECEMBER 30, 2000 (IN THOUSANDS) Black White White Corporation Corporation Corporation per Books per Books Fair Values Cash $ 475 $ 125 $125 Receivables net Inventories Plant and equipment net 1, Cost of goods sold 1, Other expenses Total debits $4,400 $1,400 Accounts payable $ 300 $ 180 $180 Other liabilities Capital stock, $10 par 1, Additional paid-in capital Retained earnings Sales 1, Total credits $4,400 $1,400 required by APB Opinion No. 16 and is consistent with the pooling concept of combining operations and shareholders interests without an acquisition and without raising new capital. For example, costs of registering and issuing securities, providing stockholders with information, paying accountants and consultants fees, and paying finder s fees to those who discovered the combinable situation were recorded as expenses of the combined entity in the period in which they were incurred. If Jake or Pete Corporation in the preceding cases had incurred accountants fees, consultants fees, costs of security registration, and other costs of combining, the combined net assets of the surviving entity would have been less and combined expenses would have been greater. However, the capital stock and pooled retained earnings recorded at April 1, 2001, would have been the same. As discussed previously, financial statements of a pooled entity for the year of combination should have been presented as if the combination had been consummated at the beginning of the period. In addition, if comparative financial statements for prior years were presented, they must have been restated on a combined basis with disclosure of the fact that the statements of previously separate companies had been combined. 5 POOLING AND PURCHASE METHODS COMPARED Comparative Illustration of the Pooling and Purchase Methods Comparative trial balances for Black Corporation and White Corporation at December 30, 2000, just before the Black and White merger, together with the fair value of White s identifiable assets and liabilities, are shown in Exhibit 4. The Black and White merger was consummated on December 31, 2000, with Black Corporation, the surviving entity, issuing 50,000 shares of $10 par common stock with a total market value of $885,000 for the net assets of White Corporation. The cost of registering and issuing the common 5 APB Opinion No. 20, Accounting Changes, paragraph 34. Restatement of all prior-period financial statements presented is required for a change in the reporting entity if the results are material. Electronic Supplement to Chapter 1 7

8 EXHIBIT 1-5 Differences in Recording the Black and White Merger Under the Pooling of Interests and Purchase Methods Pooling of Interests Issuance of Securities Investment in White (+A) Purchase Capital stock, $10 par (+SE) Additional paid-in capital (+SE) Retained earnings (+SE) 110 Direct Costs of Combination Expenses (E, SE) 60 Investment in White (+A) 40 Additional paid-in capital ( SE) 20 Cash ( A) Allocation of Investment Cash (+A) Receivables net (+A) Inventories (+A) Plant and equipment net (+A) Goodwill (+A) 100 Costs of goods sold (E, SE) 325 Other expense (E, SE) 100 Accounts payable (+L) Other liabilities (+L) Sales (R, +SE) 450 Investment in White ( A) stock was $20,000, and other direct costs of the business combination amounted to $40,000. These costs were paid by Black Corporation on December 31, JOURNAL ENTRIES Journal entries to record the Black and White merger as a pooling of interests are compared with entries necessary to record the merger as a purchase in Exhibit 5. The first set of entries compares the differences in recording the stock issued by Black Corporation in the merger. Under the pooling method, we record the investment in White at $650,000, the book value of White s net assets on January 1, 2000 (capital stock plus additional paid-in capital plus retained earnings). Under the purchase method, we record the investment in White at the $885,000 market value of the shares issued by Black Corporation on December 31, 2000, the date on which the business combination was consummated. We combine the retained earnings of Black and White in the entry to record the stock issuance under the pooling of interests method, but there is no change in Black Corporation s retained earnings when recording the combination as a purchase. The second section of Exhibit 5 shows journal entries to record additional costs of the business combination under the pooling and purchase methods. All additional costs of combination are expenses when recording the combination as a pooling of interests. Under the purchase method, we charge security registration and issuance costs ($20,000) against additional paid-in capital, and add the other direct costs of combination ($40,000) to the cost of acquiring White Corporation. A third set of comparative journal entries in Exhibit 5 shows assignment of the investment in White balance to specific assets and liabilities, and in the case of a pooling of interests, to sales and expenses. We record assets and liabilities at their fair market values when applying the purchase 8 ADVANCED ACCOUNTING

9 EXHIBIT 1-6 Comparative Financial Statements for the Black and White Merger in the Year of Business Combination BLACK CORPORATION COMPARATIVE FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 2000 Pooling of Interests Method Purchase Method Income Statement Sales $ 2,000 $ 1,550 Cost of sales (1,325) (1,000) Other expenses (485) (325) Net income $ 190 $ 225 Retained Earnings Statement Retained earnings January 1, 2000 (as reported) $ 650 $ 650 Increase from pooling 110 Retained earnings January 1, 2000 (as restated) 760 Net income Retained earnings December 31, 2000 $ 950 $ 875 Balance Sheet Assets Cash $ 540 $ 540 Receivables net Inventories 1,000 1,050 Plant and equipment net 1,550 1,650 Goodwill 100 Total assets $ 3,990 $ 4,240 Liabilities and stockholders equity Accounts payable $ 480 $ 480 Other liabilities Capital stock, $10 par 2,000 2,000 Additional paid-in capital Retained earnings Total liabilities and stockholders equity $ 3,990 $ 4,240 method and at their book values under the pooling method. We record the excess of investment cost ($925,000) over the fair value of identifiable net assess ($825,000) as goodwill under the purchase method. The excess of fair value over historical cost to White, which was allocated to inventories ($50,000) and to plant and equipment ($100,000) under purchase accounting, also will increase future expenses and decrease future income as compared with the pooling method. Thus, income of Black Corporation in subsequent years will be lower if we record the Black and White merger as a purchase rather than a pooling of interests. FINANCIAL STATEMENTS Exhibit 6 compares the combined financial statements for Black Corporation for 2000 for the purchase and pooling methods. The differences in the comparative income statements result from the combining of sales and expenses under the pooling method but Electronic Supplement to Chapter 1 9

10 not under purchase accounting. An additional difference is that we charge additional costs of combination to expense under the pooling method. Total assets of Black Corporation at December 31, 2000, were $4,240,000 under the purchase method and $3,990,000 under the pooling method. This $250,000 balance-sheet difference is the result of allocating the excess of cost over book value acquired to inventories, plant and equipment, and goodwill under the purchase method. The comparative balance sheets in Exhibit 6 show additional paid-in capital of $240,000 and $565,000 under the pooling and purchase methods, respectively. Additional paid-in capital under the pooling method is equal to the excess of paid-in capital of the combining companies ($2,240,000) over the capital stock of the combined entity ($2,000,000). The $565,000 additional paid-in capital under purchase accounting is equal to the $200,000 beginning balance, plus $385,000 from the issuance of the 50,000 shares in excess of par value, less the $20,000 cost of registering and issuing the securities in the business combination. The pooled retained earnings of Black Corporation exceed the retained earnings of Black under the purchase method by $75,000. This difference stems from combining retained earnings under the pooling method, as well as from the income differences discussed earlier. Note that significant differences in accounting for the retained earnings of a combined entity are possible under generally accepted accounting principles. Accordingly, users of financial statements of combined entities should be careful not to interpret the reported retained earnings balances as amounts legally available for dividends. Such interpretations are questionable when the reports are for separate legal entities, and they are even more suspect when we combine two or more entities into one accounting entity. DISCLOSURE REQUIREMENTS FOR A POOLING The combined corporation must disclose that the business combination was accounted for as a pooling of interests. In addition, financial statement notes for the period of pooling should include the names of the combined companies, a description of the shares issued, the details of the results of operations of the separate companies before pooling, the nature of any asset adjustments to adopt the same accounting practices, the details of the effect on retained earnings of changing the fiscal period of a combining company, and a reconciliation of the issuing company s revenue and earnings with combined amounts after the pooling. When a new corporation was formed in a pooling, this last disclosure requirement could be met by disclosing the earnings of the separate companies that comprised the combined earnings for the period. 7 ASSIGNMENT MATERIAL W 1-1 W 1-2 W 1-3 W 1-4 W 1-5 W 1-6 W 1-7 Explain the basic differences between the purchase and pooling of interests methods of accounting for business combinations. Identify the twelve conditions that must be met for a business combination to be accounted for as a pooling of interests. Ordinarily, the retained earnings of the surviving corporation in a pooling of interests would be equal to the combined retained earnings of the combining companies. Under what conditions would be combined retained earnings be less than or greater than the total retained earnings of the combining companies? The term instant earnings has been cited as an undesirable feature of the pooling of interests method. In what sense does pooling of interests accounting give rise to so-called instant earnings? Explain. Compare the costs of effecting a business combination under the purchase and pooling of interests methods. Why are purchase and pooling of interests business combinations accounted for differently? Explain how the direct and indirect costs of combination are recorded for purchase business combinations and for poolings of interests. 7 APB Opinion No. 16, paragraph ADVANCED ACCOUNTING

11 W 1-8 W Which one of the following items is a requirement for a pooling of interests? a. Fair value accounting b. Amortization of goodwill c. Exchange of common shares d. Dissolution of all but one of the combining entities 2. A pooling of interests was consummated with the stockholders of the other combining corporation exchanging two of their shares for each share of stock of the issuing company. The exchange ratio in this pooling is: a. 2 b. 0.5 c. 3 d The issuing company in a pooling of interests may issue treasury shares for the stock of the other combining corporation if the treasury stock is: a. Acquired for cash to affect the business combination b. Accounted for on a cost basis c. Reissued at its current market value d. First retired and then reissued 4. Corporation A and Corporation B combined in 2000 in a pooling of interests business combination. Which of the following dates is the date of initiation of the plan for this business combination? a. A consulting firm arranged a meeting between the officers and directors of the two companies on January 5, b. A public announcement was made on March 1, 2000, that the exchange ratio would be 1.2 to 1. c. Stockholders were notified that the officers of the two companies had agreed upon the 1.2 to 1 exchange ratio on March 15, d. Stockholders of the two companies voted to accept the terms of the proposed business combination on May 15, Which one of the following criteria is not a condition for a pooling of interests? a. Each of the combining firms must be autonomous. b. The combination must be completed in a single transaction or in accordance with a specific plan that is completed within one year of its initiation. c. Each combining corporation other than the issuing corporation must be dissolved as of the date of which the combination is consummated. d. The proportionate interest of each individual common stockholder in each of the combining companies remains the same as a result of stock exchanged to effect the combination. 6. When retained earnings of a combining company in a pooling are adjusted to conform accounting principles with those of the pooled entity, the accounting change: a. Disqualifies the combination for pooling of interests treatment b. Is recorded as an initial entry in the pooled firm s records c. Is unacceptable if the effect is to increase retained earnings d. Is acceptable if the change would have been appropriate for the separate company 1. The criteria for a pooling of interests are not met if: a. The combined entity plans to sell duplicate facilities b. The issuing company pays cash for 1% of the shares of the other combining company between the initiation and consummation dates c. The voting rights relating to the shares issued to effect the pooling will not be effective until a year after consummation of the plan d. The business combination takes more than six months from the date of initiation to complete 2. The exchange ratio in a pooling of interests is the: a. Ratio of the market value per share of the issuing company s stock to the market value per share of the combining company s stock Electronic Supplement to Chapter 1 11

12 b. Ratio of the total market value of stock issued to the total market value of stock received c. Ratio of the number of shares of the issuing company s stock to be exchanged for each share of the other combining company s stock on the date of consummation d. Ratio of the number of shares of the acquired company s stock to be exchanged for each share of the issuing company s stock 3. The expensing of indirect costs of a business combination is required for: a. Purchase but not pooling combinations b. Pooling but not purchase combinations c. Both purchase and pooling combinations d. Neither purchase nor pooling combinations 4. The maximum retained earnings that can be combined in a pooling of interests is reduced by the excess of: a. Paid-in capital of the combining entities over the capital stock of the pooled entity b. Additional paid-in capital of the combining entities over capital stock of the pooled entity c. Capital stock of the pooled entity over total paid-in capital of the combining entities d. Capital stock of the pooled entity over additional paid-in capital of the combining entities 5. In a pooling of interests business combination, stock of the other combining company held by the issuing corporation is treated as: a. An investment to be accounted for under the equity method b. Stock retired in the pooling c. Treasury stock of the pooled entity d. None of the above 6. The capital stock of the surviving entity in a 100% pooling of interests is equal to: a. Capital stock of the issuing company plus the capital stock issued for shares of the other combining companies b. Combined capital stock of the combining entities c. Capital stock of the pooled entity over the paid-in capital of the other combining entities d. None of the above W Immediately before the business combination of Posey and Sharrel Corporations in which Sharrel Corporation was dissolved, Posey held 500 shares of Sharrel common stock, and Sharrel held 200 shares of Posey common stock. Posey issued 4,750 of its shares for the remaining 9,500 outstanding shares of Sharrel when the business combination was consummated. Which statement regarding this pooling of interests is correct: a. The 500 shares of Sharrel stock held by Posey will be treated as shares retired in the pooling of interests. b. The 200 shares of Posey stock held by Sharrel will be treated as treasury shares of the pooled entity. c. The exchange ratio in this pooling is 0.5 to 1. d. All of the above statements are correct. Pappy Corporation exchanged 11,000 of its common shares for 33,000 common shares of Snippy Corporation in consummation of a business combination on July 1, Just before consummation, Pappy held 2,000 shares of Snippy common stock and Snippy held 1,000 shares of Pappy common stock. After the business combination, 2,000 shares of Snippy stock remained outstanding. REQUIRED 1. What was the exchange ratio in the business combination? 2. How many shares of Snippy common stock were outstanding before consummation of the business combination? 3. How many shares will be assumed to be exchanged under the substantially all test for a pooling? 4. Is the substantially all test for a pooling of interests met in the Pappy-Snippy business combination? 12 ADVANCED ACCOUNTING

13 W 1-11 Baloney Corporation and Nayle Company enter into a plan of business combination in which Baloney will issue one share of common stock for every three shares of Nayle common stock. On the date of initiation of the business combination, Baloney held 500 shares of Nayle s common stock, and Nayle held 100 shares of Baloney common stock. Between the date of initiation and the date of consummation, Baloney purchased an additional 400 shares of Nayle common in the stock market. Nayle had 50,000 shares of common stock outstanding throughout the period. On the date of consummation, Baloney issued 16,000 shares of common stock for 48,000 shares of Nayle s common stock. Nayle s old stockholders still hold, 1,100 shares of Nayle common. REQUIRED: How many shares of Nayle stock are assumed to be exchanged in the combination under the substantially all test for a pooling of interests? W 1-12 W 1-13 [AICPA adopted] 1. Dan Corporation offered to exchange two shares of Dan common stock for each share of Boone Company common stock. On the initiation date, Dan held 3,000 shares of Boone common and Boone held 500 shares of Dan common. In later cash transactions, Dan purchased 2,000 shares of Boone common and Boone purchased 2,500 shares of Dan common. At all times, the number of common shares outstanding was 1,000,000 for Dan and 100,000 for Boone. After consummation, Dan held 100,000 Boone common shares. The number of shares considered exchanged in determining whether this combination should be accounted for by the pooling of interests method is: a. 190,000 b. 95,000 c. 93,500 d. 89, The business combination of Jax Company the issuing company and the Bell Corporation was consummated on March 14, At the initiation date, Jax held 1,000 shares of Bell. If the combination is accounted for as a pooling of interests, the 1,000 shares of Bell held by Jax will be accounted for as: a. Retired stock b. 1,000 shares of treasury stock c. (1,000/the exchange rate) shares of treasury stock d. (1,000 the exchange rate) shares of treasury stock Carrier Corporation issued 100,000 shares of $20 par common stock for all the outstanding stock of Homer Corporation in a business combination consummated on July 1, Carrier Corporation common stock was selling at $30 per share at the time the business combination was consummated. Out-of-pocket costs of the business combination were as follows: Finder s fee $50,000 Accountants fee (advisory) 10,000 Legal fees (advisory) 20,000 Printing costs 5,000 SEC registration costs and fees 12,000 Total $97, If the business combination was treated as a pooling of interests, the acquisition cost of the combination would have been: a. $3,097,000 b. $2,097,000 c. $2,080,000 d. None of the above 2. If the combination was treated as a purchase, the acquisition cost of the combination would have been: a. $3,097,000 b. $3,080,000 c. $3,017,000 d. None of the above Electronic Supplement to Chapter 1 13

14 W 1-14 Franklin and Harlow Corporations were combined on April 1, 2000, in a pooling of interests business combination, and Harlow was dissolved. For the year 2000, the companies had the following earnings records: Franklin Corporation (January 1 April 1) $ 40,000 Franklin Corporation (April 1 December 31) 660,000 Harlow Corporation (January 1 April 1) 200, Franklin, the surviving corporation, would have reported income for 2000 of: a. $660,000 b. $700,000 c. $860,000 d. $900,000 W Franklin s financial statement notes for 2000 should have included: a. A description of all classes of preferred and common stock exchanged in the consummation of the pooling b. A reconciliation of Franklin s revenue and earnings with combined amounts after the pooling of interests c. A description of any contingent payments that may result in 2001 from the pooling of interests d. The cost of acquiring Harlow Patter Corporation issued 500,000 shares of its own $10 par common stock for all the outstanding stock of Simpson Corporation in a merger consummated on July 1, On this date, Patter stock was quoted at $20 per share. Summary balance sheet data for the two companies at July 1, 2000, just before combination, were as follows (in thousands): Patter Simpson Current assets $18,000 $1,500 Plant assets 22,000 6,500 Total assets $40,000 $8,000 Liabilities $12,000 $2,000 Common stock, $10 par 20,000 3,000 Additional paid-in-capital 3,000 1,000 Retained earnings 5,000 2,000 Total equities $40,000 $8, If the business combination was treated as a pooling of interests, the pooled retained earnings immediately after the combination would have been: a. $5,000 b. $6,000 c. $7,000 d. $8, If the business combination was treated as a pooling of interests, the additional paid-in capital immediately after the combination would have been: a. $5,000 b. $4,000 c. $3,000 d. $2, If the business combination was treated as a purchase and Simpson s identifiable net assets had a fair value of $9,000,000, Patter s balance sheet immediately after the combination would have showed goodwill of: a. $1,000 b. $2,000 c. $3,000 d. $4, ADVANCED ACCOUNTING

15 W 1-16 IceAge Company issued 120,000 shares of $10 par common stock with a fair value of $2,550,000 for all the voting common stock of Jester Company. In addition, IceAge incurred the following additional costs: Legal fees to arrange the business combination $25,000 Cost of SEC registration, including accounting and legal fees 12,000 Cost of printing and issuing new stock certificates 3,000 Indirect costs of combining, including allocated overhead and executive salaries 20,000 Immediately before the business combination in which Jester Company was dissolved, Jester s assets and equities were as follows (in thousands): Book Value Fair Value Current assets $1,000 $1,100 Plant assets 1,500 2,200 Liabilities Common stock 2,000 Retained earnings 200 REQUIRED: Assume that the business combination is a pooling of interests. Prepare all journal entries on IceAge s books to record the business combination. W 1-17 On January 1, 2000, Placate Corporation held 2,000 shares of Service Corporation common stock acquired at $15 per share several years earlier. On this date, Placate issued 1.5 of its $10 par shares of each of the other 98,000 outstanding shares of Service in a pooling of interests in which Service Corporation was dissolved. Service Corporation s after-closing trial balance on December 31, 1999, consisted of the following (in thousands): Current assets $ 800 Plant and equipment net 1,500 Liabilities $ 200 Capital stock, $5 par 500 Additional paid-in capital 1,000 Retained earnings 600 $2,300 $2,300 REQUIRED: Prepare a journal entry (or entries) on Placate s books to account for the pooling of interests. (Hint: Do not forget to consider the 2,000 shares of Service held by Placate on January 1, 2000.) W 1-18 Blair Corporation, the surviving company in a pooling of interests, exchanged 20,000 of its treasury shares for 10,000 shares of Tuby Corporation s common stock on July 1. At the time of the exchange, Tuby held 1,000 shares of Blair stock acquired several years ago at $10 per share. The equity accounts of Blair and Tuby immediately before the pooling were as follows (in thousands): Blair Tuby Capital stock, $10 par $700 $100 Additional paid-in capital Retained earnings Treasury stock, 20,000 shares 180 Total stockholders equity $760 $219 REQUIRED: Prepare the stockholders equity section of Blair s balance sheet immediately after the business combination. W 1-19 Tansy Corporation issued its own common stock for all the outstanding shares of Vatters Corporation in a pooling of interests business combination on January 1, The balance sheets of the two companies at December 31, 1999 were as follows (in thousands): Electronic Supplement to Chapter 1 15

16 Tansy Vatters Current assets $15,000 $ 4,000 Plant assets net 40,000 6,000 Total assets $55,000 $10,000 Liabilities $10,000 $ 3,000 Common stock, $10 par 30,000 4,000 Additional paid-in capital 3,000 2,000 Retained earnings 12,000 1,000 Total equities $55,000 $10,000 REQUIRED: Prepare balance sheets for Tansy Corporation on January 1, 2000, immediately after the pooling of interests in which Vatters was dissolved under the following assumptions: 1. Tansy issued 800,000 of its common shares for all of Vatter s outstanding shares. 2. Tansy issued 1,000,000 of its common shares for all of Vatters s outstanding shares. W 1-20 Gladfresh and Farmstone Corporations entered into a business combination accounted for as a pooling of interests in which Farmstone was dissolved. Net assets and stockholders equities of the two companies immediately before the pooling follow (in thousands): Gladfresh Farmstone Net assets $1,000 $800 Capital stock, $10 par $ 400 $200 Additional paid-in capital Total paid-in capital Retained earnings Total stockholders equity $1,000 $800 REQUIRED: 1. Prepare the journal entry on Gladfresh Corporation s books to record the pooling with Farmstone if Gladfresh issued 35,000, $10 par common shares in exchange for all Farmstone common shares. 2. Prepare the journal entry on Gladfresh Corporation s books to record the pooling with Farmstone if Gladfresh issued 77,000, $10 par common shares in exchange for all Farmstone common shares. W 1-21 Quatro Corporation initiated a plan to pool its interests with Tertio Corporation on January 1, On this date: 1. Quatro held 40,000 of Tertio s 750,000 shares of authorized and issued common stock, acquired by Quatro at a cost of $600, Tertio held 5,000 shares of Quatro s $10 par common stock acquired at $60 per share. 3. Tertio held 50,000 shares of its own common stock (treasury shares) reacquired at $30 per share. On October 1, 2000, Quatro issued 330,000 of its $10 par shares for 660,000 shares of Tertio. The stockholders equity of Tertio on October 1, just before the exchange of shares in which Tertio was dissolved, consisted of the following: Capital stock, $10 par $7,500,000 Retained earnings 3,500,000 Less: Treasury shares (1,500,000) Total stockholders equity $9,500,000 The direct costs of the business combination consisted of $20,000 to register and issue the common stock and $380,000 in other costs of combination. These costs were paid in cash by Quatro. REQUIRED: 1. How many of Tertio s shares are required to be exchanged to meet the substantially all test for a pooling of interests? 2. How many of Tertio s shares will be assumed to be exchanged to determine if the substantially all test is met? 16 ADVANCED ACCOUNTING

17 3. Prepare the journal entries on Quatro s books in summary form to record the business combination as a pooling. (Hint: Use an other net assets account to record Tertio s net assets other than its investment in Quatro, and make a separate entry to account for Pond s investment in Tertio and Tertio s investment in Quatro.) W 1-22 On January 2, 2000, Dual and Cowbell Corporations merged their operations through a business combination accounted for as a pooling of interests. The $300,000 direct costs of combination were paid in cash by the surviving entity on January 2, At December 31, 1999, Cowhill held 25,000 shares of Dual stock acquired at $20 per share. Summary balance sheet information for Dual and Cowhill corporations at December 31, 1999, was as follows (in thousands): Dual Cowhill Corporation Corporation Current assets $ 6,500 $ 4,500 Plant and equipment net 10,000 10,000 Investment in Dual 500 Total assets $16,500 $15,000 Liabilities $ 1,500 $ 3,000 Common stock, $10 par 10,000 8,000 Additional paid-in capital 2,000 3,000 Retained earnings 3,000 1,000 Total equities $16,500 $15,000 REQUIRED: 1. Assume that the surviving corporation was Dual Corporation and that Dual issued 1,000,000 shares of its own stock for all the outstanding shares of Cowhill Corporation. a. Prepare journal entries on the books of Dual Corporation to record the business combination. b. Prepare a balance sheet for Dual Corporation on January 2, 2000, immediately after the business combination. 2. Assume that the surviving corporation was Cowhill Corporation and that Cowhill issued 1,200,000 shares of its own stock for all the outstanding shares of Dual Corporation. a. Prepare journal entries on the books of Cowhill Corporation to record the business combination. b. Prepare a balance sheet for Cowhill Corporation on January 2, 2000, immediately after the business combination. W 1-23 Patio Corporation was formed on January 2, 2000, to consolidate the operations of EPA Corporation and Century Corporation. Summary balance sheets for the two companies at December 31, 1999, were as follows (in thousands): EPA Century Corporation Corporation Assets Cash $ 3,000 $ 1,000 Receivables net 3,500 1,500 Inventories 6,000 7,000 Land 1,000 2,000 Building net 7,500 3,000 Equipment net 3,000 5,500 Total assets $24,000 $20,000 Liabilities and Stockholders Equity Accounts payable $ 2,700 $ 2,300 Bonds payable 3,000 Capital stock 10,000 6,000 Additional paid-in capital 4,300 2,700 Retained earnings 4,000 9,000 Total liabilities and stockholders equity $24,000 $20,000 ADDITIONAL INFORMATION 1. The stockholders of the combining corporations agreed to the following plan of combination: a. Stockholders of EPA Corporation were to receive 1,300,000 common shares of $10 par stock of Patio Corporation for their 5,000,000 shares of $2 par capital stock. Electronic Supplement to Chapter 1 17

18 b. Stockholders of Century Corporation were to receive 1,200,000 common shares of Patio Corporation for their 1,000,000 shares of $6 stated value capital stock. c. Both EPA Corporation and Century Corporation were to be dissolved. 2. The business combination was treated as a pooling of interests with January 2, 2000, as the date of initiation and consummation of the plan. 3. The inventories of Patio were to be maintained on a FIFO basis. Accordingly, Century s December 31, 1999, LIFO inventory was adjusted to its $8,000,000 FIFO cost. 4. Costs of registering and issuing securities in the combination amounted to $60,000, and other direct costs of combination totaled $140,000. These costs were paid by Patio on January 2, 2000, from cash obtained from the other combining companies. REQUIRED 1. Prepare journal entries on the books of Patio Corporation to: a. Record the issuance of 1,300,000 shares to the stockholders of EPA Corporation b. Record the issuance of 1,200,000 shares to the stockholders of Century Corporation c. Record payment of the costs of business combination 2. Prepare a balance sheet for Patio Corporation at January 2, 2000, immediately after the business combination has been consummated. W 1-24 On January 1, 2000, Ainsley Corporation issued 500,000 shares of its capital stock for all of Biker Corporation s outstanding shares and Biker was dissolved. The fair value of Ainsley s common stock on this date was $25 per share. The book values and fair values of Ainsley and Biker at December 31, 1999, were as follows (in thousands): Ainsley Corporation Biker Corporation Book Value Fair Value Book Value Fair Value Assets Cash $ 3,000 $ 3,000 $ 1,000 $ 1,000 Receivables net 5,500 5,500 2,000 2,000 Inventories (LIFO) 6,000 7,000 3,500 4,000 Other current assets 1,500 1, Plant assets net 16,000 19,000 5,000 7,400 Total assets $32,000 $36,000 $12,000 $15,000 Equities Accounts payable $ 5,000 $ 5,000 $ 1,800 $ 1,800 Other liabilities 3,800 4,000 3,200 3,000 Capital stock, $10 par 15,000 3,000 Other paid-in capital 3,000 1,200 Retained earnings 5,200 2,800 Total equities $32,000 $12,000 REQUIRED: Prepare comparative balance sheets for Ainsley Corporation immediately after the business combination, assuming that (a) the combination was a pooling of interests and (b) the combination was a purchase. 18 ADVANCED ACCOUNTING