Mergers and Acquisitions Paper 6

(c) The fair value of the 20,000 (100,000 × 20%) shares of noncontrolling interest in Stone on the date of acquisition is $1,040,000 (20,000 shares × $52 per share). This amount is adjusted for the noncontrolling interest’s share of net income and dividends received as calculated below. Fair value of noncontrolling interest, acquisition date $1,040,000 Plus: Share of net income (20% × $280,000) 56,000 Less: Share of dividends (20% × 50,000) (10,000) Noncontrolling interest 12/31/Y1 $1,086,000

(d) The requirement is to determine which accounting concept relates to the preparation of consolidated financial statements. Answer (d) is correct because when a parentsubsidiary relationship exists, the financial statements of each separate entity are brought together, or consolidated. When financial statements represent a consolidated entity, the concept of economic entity applies. Answer (a) is incorrect because reliability is a concept that applies to all financial statements, not just consolidated financial statements. Reliability is a primary quality that makes accounting information useful for decision making. This quality should be found in all statements. Answer (b) is incorrect because the concept of materiality applies to all financial statements, not just consolidated financial statements. The concept of materiality, as applied to financial statements, deals with the impact an item in the financial statements will have on a user’s decision-making process. Answer (c) is incorrect because the concept of legal entity refers to the form or type of combination that takes place between entities (i.e., mergers, consolidations or acquisitions), not the basis on which financial statements are prepared.

(b) In general, all assets and liabilities (including equipment) should be reported at market value. The excess of the equipment’s market value over its carrying amount is allocated to the equipment and amortized over the equipment’s useful life. The unamortized portion of the excess of the market value over the carrying amount of the equipment is then reported as part of plant and equipment. Only the excess of the acquisition cost over the market value of the net identifiable assets acquired is reported as goodwill. The excess of the market value over the carrying amount of the equipment is capitalized and subsequently amortized over the equipment’s useful life, not expensed on the date of the acquisition.

(a) When two companies own stock in each other, a reciprocal ownership relationship exists. In this case, Pride (the parent) owns 80% of Simba (the sub), and Simba owns 10% of Pride. When Pride declares a cash dividend, 90% of it is distributed to outside parties and 10% goes to Simba. Because Simba is part of the consolidated entity, its 10% share of Pride’s dividend is eliminated when determining consolidated dividends declared. Thus, only 90% of dividends declared by Pride will be reported in the consolidated financial statements. When Simba declares a dividend, 80% of the dividend is distributed to Pride (the parent), and 20% is distributed to outside parties (the noncontrolling interest of Simba stock). The 80% share to Pride is eliminated when determining consolidated dividends declared because it represents an intercompany transaction. The remaining 20% to the noncontrolling interest is likewise not included in consolidated dividends declared because, from the parent company’s point of view, subsidiary dividends do not represent dividends of the consolidated entity and must be eliminated.

(c) It is presumed that an entity with equity of less than 10% of total assets does not have sufficient funding to finance its activities unless there is definitive evidence to the contrary (e.g., a source of outside financing).

(b) A variable interest entity should be consolidated by the primary beneficiary. A primary beneficiary has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance, and has the obligation to absorb the majority of the entity’s expected losses if they occur, or receive the majority of the residual returns if they occur, or both.

(a) The determination of whether an entity is a variable interest entity and which enterprise should consolidate that entity is made at the time the enterprise initially gets involved with the variable interest entity and is reassessed on an ongoing basis.

(d) Accounting changes that result in financial statements that are, in effect, financial statements of a different reporting entity (such as presenting consolidated statements in place of statements of individual companies) should be reported by restating the financial statements of all prior periods presented so that the resulting restated prior periods’ statements on a consolidated basis are the same as if the subsidiary had been consolidated since it was acquired.

(c) Unrealized profit in ending inventory arises when intercompany sales are made at prices above cost and the merchandise is not resold to third parties prior to year-end. The profit is unrealized because the inventory has not yet been sold outside of the consolidated entity. In this case, there is no unrealized profit on the sales to Dean because the consolidated statements would not include Dean, and the equity method is not applicable. (Clark owns only 15% of Dean). However, there is unrealized profit on the materials sold by Kent, a wholly owned subsidiary, to Clark. Sixty thousand dollars of the $240,000 of materials sold by Kent to Clark remains in ending inventory. The gross profit Kent recognized on this $60,000 of materials at the time of sale was $12,000 ($48,000 ÷ $240,000 = 20% gross profit rate; 20% × $60,000 = $12,000). For the consolidated entity, this $12,000 gross profit has not been earned and must be eliminated. Therefore, consolidated current assets should be $308,000 ($320,000 – $12,000).

(d) The requirement is to determine the amount of selling expenses to be reported in Pard’s year 1 consolidated income statement. Pard’s selling expenses for year 1 include $50,000 in freight-out costs for goods sold to Seed, its subsidiary. This $50,000 becomes part of Seed’s inventory because it is a cost directly associated with bringing the goods to a salable condition. None of the $50,000 represents a selling expense for the consolidated entity, and $1,450,000 ($1,100,000 + $400,000 – $50,000) should be reported as selling expenses in the consolidated income statement.