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CHAPTER 12

ACQUISITIONS AND CONSOLIDATED STATEMENTS


Changes from Eleventh Edition
Updated from Eleventh Edition.
Approach
The results under the purchase method are of considerable importance, and also of considerable interest to
the student. The results are mystifying at first, but something worth learning about. It is probably
desirable to go through the illustrative situation in some detail.
The material on consolidated statements is brief, but we believe adequate for the objective of this book.
Students should be able to grasp the general idea of what is going on without much difficulty and
therefore should understand the meaning of consolidated statements when they read them. They should
not, of course, be left with the impression that they know all about how to prepare such statements, and
reference to the number of pages devoted to this topic in an intermediate or advanced text may be
desirable: in some texts, 200 pages. If instructors wish to go further, they can develop worksheets for the
asset valuation or minority interest situations.
Cases
Hardin Tool Company gives a simple set of numbers to illustrate the effect of purchase method
accounting, both at the time of acquisition and subsequently. It provides an excellent overview.
Carter Corporation is a straightforward problem on the preparation of consolidated statements.
Keanes Acquisition of Metro Information Services is an actual merger that can be used to illustrate the
purchase method.
Productos Finas a consolidation exercise. This case is new with the Twelfth Edition.
Problems
Problem 12-1
Company P should use the equity method. It owns more that 20 percent of Company S.

Investment on January 1
dr. Investment.....................................................................................................................................................................
600,000
cr. Cash...........................................................................................................................................................................
600,000

Income and Dividends


dr. Investment.....................................................................................................................................................................
120,000*
cr. Equity Income............................................................................................................................................................
120,000
* ($300,000 x .4)

dr. Cash..............................................................................................................................................................................
40,000*
cr. Investment..................................................................................................................................................................
40,000
* ($100,000 x .4)
On December 31, the investment in Company P would be reported as $680,000 ($600,000 + $120,000 $40,000).
1

Accounting: Text and Cases 12e Instructors Manual

Anthony/Hawkins/Merchant

Problem 12-2
Company P should use the cost method to account for its investment in Company S. Company P own less
than 20 percent of Company S.

Original Investment
dr. Investment..................................................................................................................................................................................
1,000,000
cr. Cash........................................................................................................................................................................................
1,000,000

Dividend Payment received


dr. Cash...........................................................................................................................................................................................
25,000
cr. Dividend Income.....................................................................................................................................................................
25,000

Problem 12-3
Year 1
(1) dr. Investment.......................................................................................................................................................................
700,000
cr. Cash.............................................................................................................................................................................
700,000
(2)

dr. Investment.......................................................................................................................................................................
24,500*
cr. Equity Income..............................................................................................................................................................
24,500
* ($70,000 x .35)

(3)

dr. Cash.................................................................................................................................................................................
21,000*
cr. Investment...................................................................................................................................................................
21,000
*($60,000 x .35)

Year 2
(1) dr. Investment.......................................................................................................................................................................
75,000
cr. Cash.............................................................................................................................................................................
75,000
(2)

No entry.

(3)

dr. Investment.......................................................................................................................................................................
60,000
cr. Equity Income............................................................................................................................................................
60,000
(150,000 x .4)

(4)

dr. Cash.................................................................................................................................................................................
40,000
cr. Investment...................................................................................................................................................................
40,000

Problem 12-4
Goodwill Calculation

Ba Be
Current assets..................................................................................................................................................................................
$150,000 (Appraised value)
Net fixed assets...............................................................................................................................................................................
555,600 (Appraised value)
Other assets.....................................................................................................................................................................................
134,400 (Appraised value)
Total Assets...............................................................................................................................................................................
840,000
Liabilities........................................................................................................................................................................................
192,000
Net Assets.................................................................................................................................................................................
648,000
Purchase price.................................................................................................................................................................................
870,000
Goodwill.........................................................................................................................................................................................
$222,000
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2007 McGraw-Hill/Irwin

Chapter 12

Consolidated Balance Sheet


Elder
BaBe
Consolidated
Current assets.....................................................................................................................................................................
$ 1,104,000
$150,000
$ 1,254,000
Net fixed assets..................................................................................................................................................................
32,814,000
555,600
33,369,600
Other assets........................................................................................................................................................................
14,412,000
134,400
14,546,400
Goodwill............................................................................................................................................................................
----222,000
Total assets...................................................................................................................................................................
$49,392,000

Current liabilities................................................................................................................................................................
$ 3,600,000
$ 42,000
$ 3,642,000
Long-term debt...................................................................................................................................................................
15,582,000
150,000
15,732,000
Common stock...................................................................................................................................................................
24,000,000
--24,000,000
Paid-in capital....................................................................................................................................................................
5,418,000
--5,418,000
Retained earnings...............................................................................................................................................................
600,000
--600,000
Total liabilities and equity............................................................................................................................................
$49,392,000
Problem 12-5
(1)

dr. Sales (Subsidiary)...............................................................................................................................................


337,000
cr. Cost of Goods Sold.........................................................................................................................................
337,000

(2)

dr. Accounts Payable (Parent)..................................................................................................................................


73,000
cr. Accounts Receivable (Subsidiary)..................................................................................................................
73,000

(3)

dr. Loan Payable (Subsidiary)..................................................................................................................................


396,000
cr. Loan Receivable (Parent)................................................................................................................................
396,000

(4) An entry to eliminate Pebbles investment in Sandvel is necessary, although the problem does not
provide the equity amounts for Sandvel. The entry would be structured as follows:

Capital Stock (Subsidiary)..


X
Retained Earnings (Subsidiary)..............................................................................................................................
3.1 million - X
Investment in Sandvel (Parent)............................................................................................................................
3.1 million
Problem 12-6
a.

Pooling of Interests
Company
Company
Pooling of
A
B
Interests
Current assets..........................................................................................................................................................
$ 500,000
$150,000
$ 650,000
Fixed assets.............................................................................................................................................................
700,000
250,000
950,000
Totals.................................................................................................................................................................
$1,200,000
$400,000
$1,600,000

Current liabilities....................................................................................................................................................
$ 250,000
$ 75,000
$ 325,000
Long-term liabilities...............................................................................................................................................
175,000
50,000
225,000
Capital stock, $20 per.............................................................................................................................................
400,000
--660,000*
Capital stock, $10, per............................................................................................................................................
--170,000
--Additional paid-in capital.......................................................................................................................................
175,000
60,000
145,000+
Retained earnings....................................................................................................................................................
200,000
45,000
245,000
Totals.................................................................................................................................................................
$1,200,000
$400,000
$1,600,000
* $400,000 + ($650,000 / $50) x $20)
+ Plug figure (= $175,000 + $60,000 + $170,000 - $260,000)
3

Accounting: Text and Cases 12e Instructors Manual

Anthony/Hawkins/Merchant

Purchase Accounting
Company B
(Market
Company A
Value)
Purchase
Current assets.......................................................................................................................................................................
$ 500,000
$175,000
$ 575,000*
Fixed assets..........................................................................................................................................................................
700,000
325,000
1,025,000
Goodwill..............................................................................................................................................................................
----275,000+
Totals..............................................................................................................................................................................
$1,200,000
$500,000
$1,875,000

Current liabilities.................................................................................................................................................................
$ 250,000
$ 75,000
$ 325,000
Long-term liabilities............................................................................................................................................................
175,000
50,000
775,000^
Capital stock, $20 per..........................................................................................................................................................
400,000
--400,000
Capital stock, $10 per..........................................................................................................................................................
------Additional paid-in capital....................................................................................................................................................
175,000
--175,000
Retained earnings................................................................................................................................................................
200,000
--200,000
Totals..............................................................................................................................................................................
$1,200,000
$125,000
$1,875,000
* ($500,000 - $100,000) + $175,000
+ Plug ($650,000 ($500,000 - $125,000)
^ ($175,000 + $550,000) + $50,000

Cases
Case 12-1: Hardin Tool Company

Note: This case is unchanged from the Eleventh Edition.


Approach
This is a straightforward exercise to give the student practice in applying the pooling of interests and
purchase methods of accounting for a business combination. The case purposely avoids the complications
of intercompany transactions, which are dealt with in Case 12-2.
Question 1

HARDIN TOOL COMPANY


Consolidated Balance Sheets
As of the Proposed Acquisition Date
(thousands of dollars)
Assets
Pooling
Purchase
Current assets..................................................................................................................................................................................
$ 678
$ 678
Plant and equipment........................................................................................................................................................................
1,002
1,1611
Goodwill.........................................................................................................................................................................................
--2002
Total assets.................................................................................................................................................................................
$1,680
$2,039
Liabilities and Equity
Current liabilities.............................................................................................................................................................................
$ 370
$ 370
Long-term debt................................................................................................................................................................................
205
205
Common stock ($1 par)...................................................................................................................................................................
200
200
3
Additional paid-in capital................................................................................................................................................................
252
9183
*

This teaching note was prepared by James S. Reece. Copyright James S. Reece.

2007 McGraw-Hill/Irwin

Chapter 12

Retained earnings...............................................................................................................................................................
653
346
Total liabilities and equity.............................................................................................................................................
$1,680
$2,039
1

Difference between Hardins appraisal value ($600,000) and book value ($441,000) is attributable to fixed assets; hence Pratts
fixed assets are shown at $312,000 + $159,000 = $471,000 with purchase accounting, giving consolidated fixed assets of
$690,000 (Hardin) + $471,000 (Pratt) = $1,161,000.
2
Excess of purchase price (100,000 * $8 = $800,000) over fair value of net assets of Hardin ($600,000).
3
Plug figure. Students should note that with pooling treatment, owners equity equals $1,105,000, which is the sum of the
preacquisition owners equities of the two firms ($100,000 + $218,000 + $346,000 for Hardin + $40,000 + $94,000 + $307,000
for Pratt = $1,105,000). With purchase treatment consolidated owners equity reflects both the $159,000 write-up of Pratts fixed
assets and the $200,000 goodwill (excess of purchase pace over fair value of acquired net assets). With purchase accounting, the
substance of the transaction is that Hardin issued 100,000 shares for cash (cr. Cash, $800,000; cr. Stock at par, $100,000; cr.
Additional paid-in capital, $700,000); then the $800,000 cash was used to acquire $917,000 of assets ($558,000 book value +
$159,000 write-up + $200,000 goodwill) and Hardin assumed $117,000 of liabilities. The $918,000 consolidated additional
paid-in capital is thus this new $700,000 plus the $218,000 already on Hardins balance sheet.

In addition, the instructor may wish to discuss determination of Pratts purchase price and the appraisal
value of its net (particularly fixed) assets. Is the investment banker the best judge of the worth of 100,000
new shares of Hardins stock? Why not use a market price? If a market price is used, should it be the price
as of the date of the handshake agreement, the signing of a formal agreement, or the effective date of
the agreement; or should it be some sort of average market price? How can an appraiser judge fair
value of Pratts fixed assets? If an appraiser is not the best judge, then who is? Should several
independent appraisals be made? (Anyone who has had a house appraised knows the appraisals will
differ.) Of course, there are no clear answers to these questions, and the student should recognize these
gray matters that underlie the straightforward application of accounting techniques.

Question 2

HARDIN TOOL COMPANY


Condensed Consolidated Income Statement
For the First Year after Combination
(In thousands, except per share amounts)

Pooling Treatment
Sales.......................................................................................................................................................................
$3,600
Expenses................................................................................................................................................................
2,740
Income...................................................................................................................................................................
860
Income tax expense................................................................................................................................................
301
Net income.............................................................................................................................................................
$ 559

Earnings per share..................................................................................................................................................


$2.80
Purchase Treatment
Unadjusted income (as above)...............................................................................................................................
$ 860
Additional depreciation..........................................................................................................................................
161
Taxable income......................................................................................................................................................
844
Income tax expense................................................................................................................................................
295
Net income.............................................................................................................................................................
$ 549

Earnings per share..................................................................................................................................................


$2.75
1

$159,000 + 10 years = $16.000

Accounting: Text and Cases 12e Instructors Manual

Anthony/Hawkins/Merchant

Question 3
This question turns the case into an introductory finance case, with the opportunity to discuss financial
leverage. Both of these new alternatives would have to be accounted for as a purchase. Assuming the
common stock is still valued at $8 per share, the income statements would be as follows:

Preferred
Stock
Debentures
Unadjusted income..........................................................................................................................................................................
$860
$860
Additional depreciation...................................................................................................................................................................
16
16
Additional interest...........................................................................................................................................................................
--40
Taxable income...............................................................................................................................................................................
844
804
Income tax expense.........................................................................................................................................................................
295
281
Net income......................................................................................................................................................................................
549
523
Preferred dividend...........................................................................................................................................................................
40
--Income available to common..........................................................................................................................................................
$509
$523

Earnings per share (150,000 shares)................................................................................................................................................


$3.39
$3.49
The debenture alternative provides more leverage than the preferred stock alternative. In this simplified
problem, this occurs solely because the interest cost on debt is tax deductible, making the net interest cost
$26 versus the nondeductible preferred dividend of $40. If the company has the debt capacity to issue
debentures rather than preferred stock, then they should do so. However, calculation of long-term
debt/equity ratios for the four alternatives suggests that the debt capacity probably does exist. (Return on
common equity figures are shown to quantify the effect of leverage; these can be omitted if the instructor
wishes since they arc not formally covered until the next chapter.)

Debt/Equity
ROE (common)
Pooling, stock exchange:.......................................................................................................................................................
$205/$1,105 = 18.6%
$559/$1,105 = 50.6%
Purchase, stock exchange:.....................................................................................................................................................
$205/$1,464 = 14.0%
$549/$1,464 = 37.5%
Purchase, with preferred........................................................................................................................................................
$205/$1,464 = 14.0%
$509/$1,064 = 47.8%
Purchase, with debentures:....................................................................................................................................................
$605/$1,064 = 56.9%
$523/$1,064 = 49.2%

Case 12-2: Carter Corporation*


Note: This case is unchanged from the Eleventh Edition.
Approach
This case gives practice in construction of consolidated statements and is constructed in such a way that it
progresses by stages from straightforward adjustments to the more difficult and intricate adjustments.
Answers to Questions
Exhibit A is a consolidation worksheet for the problem as originally presented. The resulting financial
statements are shown in the first column of Exhibit B. It may be useful to reconcile with the beginning
retained earnings before consolidation, as follows:

This teaching note was prepared by Robert N. Anthony. Copyright Robert N. Anthony.

2007 McGraw-Hill/Irwin

Chapter 12

Carters ending retained earnings were................................................................................................................


$396,100
Carter added to retained earnings during 20xl.....................................................................................................
-27,200
Therefore, Carter retained earnings on January 1, 20xl were..............................................................................
368,900
Consolidated addition to retained earnings in 20xl..............................................................................................
44,200
Consolidated retained earnings, December 31,20x1............................................................................................
$413,100
Corrections (Question 2)
1. Diroff shareholders equity at acquisition was $142,800 ($159,800 - $17,000). Carter paid
$142,800 for 75 percent of this equity, which had a book value of 75 percent of $142,800, or
$107,100. Therefore, the initial consolidated balance sheet must show Goodwill of $35,700
(unless the assets are restated, and we have no evidence of this). The offset, at the time of
acquisition, is to Minority interest. Amortization of goodwill disallowed by FAS 1 and 2.
Minority interest would have increased by 25 percent of the increase in Diroffs retained earnings
since acquisition with a corresponding reduction in consolidated retained earnings. In summary,
minority interest would be:

At time of acquisition................................................................................................................................
$35,700
25 percent of $17,000 increase to retained earnings..................................................................................
4,250
$39,950
2. The entire $37,400 listed as other income constitutes income to the consolidated entity, so the
$30,600 erroneously subtracted from it should be added back. This increases net income and
retained earnings by $30,600. However, the assumed dividend was also subtracted erroneously
from retained earnings, so this adjustment must be reversed, leaving no net effect on consolidated
retained earnings.
Since Diroff has not paid the dividend, it must appear as one of its current liabilities. The
$22,950(75 percent) owed to Carter must be eliminated as an intercompany transaction, by
decreasing current liabilities and increasing retained earnings.
EXHIBIT A
Consolidation Worksheet
Separate
Statements
Carter
Diroff
Adjustments
Balance Sheets
Dr.
Cr.

Consolidated
Assets
Cash...................................................................................................................................................................................
57,800
20,400
78,200
Accounts receivable...........................................................................................................................................................
110,500
35,700
5,100
141,100
Inventory............................................................................................................................................................................
120,700
54,400
175,100
Investment in subsidiary.....................................................................................................................................................
142,800
--142,800
--Plant (net)...........................................................................................................................................................................
477,700
134,300
612,000
Loans receivable................................................................................................................................................................
--32,300
32,300
--Total..............................................................................................................................................................................
909,500
277,100
1,006,400
Liabilities and Equity
Current liabilities................................................................................................................................................................
88,400
62,900
5,100
146,200
Noncurrent liabilities..........................................................................................................................................................
170,000
54,400
32,300
192,100
Capital stock.......................................................................................................................................................................
255,000
102,000
102,000
255,000
Retained earnings...............................................................................................................................................................
396,100
57,800
40,800
______
413,100
Total..............................................................................................................................................................................
909,500
277,100
180,200
180,800
1,006,400
Income Statement Data
7

Accounting: Text and Cases 12e Instructors Manual

Anthony/Hawkins/Merchant

Sales................................................................................................................................................................................................
1,040,400
408,000
34,000
1,414,400
Cost of sales....................................................................................................................................................................................
816,000
299,200
34,000
1,081,200
Expenses.........................................................................................................................................................................................
234,600
61,200
295,800
Other income...................................................................................................................................................................................
37,400
--30,600
6,800
Dividends........................................................................................................................................................................................
--30,600
30,600
0

The net effect on consolidated retained earnings is:


As stated in Exhibit A..................................................................................................................................................................
$413,100
Deduct minority interest in earnings............................................................................................................................................
(4,250)
Add elimination of dividend to Carter.........................................................................................................................................
22,950
Revised retained earnings.........................................................................................................................................................
$431,800
The financial statements after these revisions are shown in the second column of Exhibit B.
Unsold Merchandise
The financial statements report $13,600 of Carter inventory that contains a 25 percent (8,500 / 34,000)
unrealized profit, $3,400. This profit must be eliminated from the consolidated inventory, minority
interest, and consolidated retained earnings. Minority interest is reduced by one-fourth of the unrealized
profit, or $850, and consolidated retained earnings is reduced by $2,550.
Dividend
The big change between the original and revised consolidated statements came from the mishandling of
dividend revenue. Correction of this change increased net income by 67 percent, net profit margin
percentage from 3.1 percent to 5.2 percent, and owners equity by 8.1 percent. The current redo was also
affected by this correction, increasing from 2.70 to 3.17. (Return on investment ratios also changed, but
these are not covered until the next chapter.) Correction for the omission of minority interest had no
impact in terms of ratio analysis, unless an analyst were to eliminate minority interest from owners
equity in doing an analysis (as is the case with some analysts). Correction for unrealized profit on
intracompany sales has a relatively minor impact on the current ratio and on inventory turnover (from
6.17 to 6.30).
Exhibit B
CARTER CORPORATION
Consolidated Financial Statements
Balance Sheet
As of December 31, 20x1
As Originally
Assets
Prepared

As Revised
Current Assets:
Cash.............................................................................................................................................................................................
$ 78,200
$ 78,200
Accounts receivable.....................................................................................................................................................................
141,100
141,100
Inventory......................................................................................................................................................................................
175,100
175,100
Total current assets
394,400
394,400
Plant (net)........................................................................................................................................................................................
612,000
612,000
Goodwill.........................................................................................................................................................................................
_________
35,700
Total assets................................................................................................................................................................................
$1,006,400
$1,042,100

2007 McGraw-Hill/Irwin

Chapter 12

Liabilities and Equity


Current liabilities................................................................................................................................................................
$ 146,200
$ 123,250
Noncurrent liabilities..........................................................................................................................................................
192,100
192,100
Minority interest.................................................................................................................................................................
39,9501
Capital stock.......................................................................................................................................................................
255,000
255,000
Retained earnings...............................................................................................................................................................
413,100
431,8001
Total liabilities and equity............................................................................................................................................
$1,006,400
$1,042,100

Income Statement
For the year ended December 31, 20x1
Sales...................................................................................................................................................................................
$1,414,400
$1,414,400
Cost of sales.......................................................................................................................................................................
1,081,200
1,081,200
Gross margin................................................................................................................................................................
333,200
333,200
Expenses............................................................................................................................................................................
(295,800)
(295,800)
Other income......................................................................................................................................................................
6,800
37,400
Net income...................................................................................................................................................................
$ 44,200
$ 74,800
1

Per question 3, each of these amounts needs to be reduced.