Accounting for Mergers and Acquisitions

Accounting for Mergers and Acquisitions

Chapter 1

Accounting for Mergers and Acquisitions


Item / Topics Covered / Level / Time
Q1.1 / Advantages of structuring a businesscombination as a stock acquisition rather than a merger. / Low / 15-20
Q1.2 / Characteristics of 1990's merger movement. / Low / 5-10
Q1.3 / Distinguishing between the acquiring and acquired companies. / Mod / 5-10
Q1.4 / Impact of allocation of purchase premium. / Mod / 5-10
Q1.5 / Rationale for criteria for identifiable intangibles. / Mod / 5-10
Q1.6 / Possible rationale for not recognizing goodwill. / High / 10-15
Q1.7 / Rationale for rules requiring that negative goodwill be allocated. / Mod / 5-10
Q1.8 / Accounting for contingency based on security prices. / Low / 10-15
Q1.9 / Comparison of amortization versus impairment approaches. / Mod / 5-10
Q1.10 / Definition and impact of reporting unit concept. / Mod / 5-10
Q1.11 / Rationale for composition of combined stockholders' equity following a pooling. (appendix) / Mod / 10-15
Q1.12 / Treatment of retained earnings in a pooling. (appendix) / Mod / 5-10



Item / Topics Covered / Level / Time
E1.1 / Journal entries to record purchase as merger and as stock acquisition. / Low / 10-15
E1.2 / The preparation of a balance sheet after business combination using alternative combination structures. / Mod / 20-25
E1.3 / Understanding a business acquisition transaction. / Low / 10-15
E1.4 / Preparation of schedule to allocate purchase premium; negative goodwill requiring two-stage allocation process. / Mod / 20-25
E1.5 / Calculation of carrying value of identifiable assets acquired and liabilities assumed in a purchase; four different fair value configurations. / Low / 10-15
E1.6 / Analyses of a two-stage acquisition. / Mod / 15-20
E1.7 / Entry for acquisition prior to completion of combination. / Mod / 10-15
E1.8 / Allocation of purchase premium to identifiable intangibles and goodwill. / Mod / 15-20
E1.9 / Postcombination balance sheet effects produced by new information relating to a preacquisition contingency. / Mod / 15-20
E1.10 / Journal entries required upon resolution of alternative contingent consideration agreements. / Mod / 10-20
E1.11 / Journal entries to record a merger as purchase and as pooling of interests. (appendix) / Low / 10-15



Item / Topics Covered / Level / Time
E1.12 / Preparation of acquisition entry under various alternatives. (appendix) / Low / 15-20
P1.1 / Journal entries to record a purchase under various terms. / Mod / 50-60
P1.2 / Preparation of the balance sheet of the acquiring firm following business combinations, and discussion of how the fair value data was used in each of the transactions. / Mod / 25-35
P1.3 / Analysis of a business combination. / High / 20-30
P1.4 / Analysis of a three-company merger. / High / 30-40
P1.5 / Analysis of purchase premium, identifiable intangible assets, and goodwill. / High / 30-40
P1.6 / Business combination before and after SFAS 141 and 142. / Mod / 15-20
P1.7 / Identification of five business factors that would give rise to goodwill; calculation of the recorded goodwill and discussion of the subsequent treatment and disclosures associated with the recorded goodwill.(CMA adapted) / Mod / 30-40
P1.8 / Journal entries to record purchase, and revise original purchase price allocation when a pre-acquisition contingency is resolved; negative goodwill. / Mod / 50-60



Item / Topics Covered / Level / Time
P1.9 / Allocation of goodwill to reporting units and subsequent impairment testing. / High / 40-50
P1.10 / Amortization and impairment testing for identifiable intangible assets and goodwill. / High / 30-40
P1.11 / Journal entries to record merger under one purchase and two pooling combination arrangements. (appendix) / Mod / 20-30
P1.12 / Preparation of post-combination balance sheet under both purchase and pooling; evaluation from investor perspective. (appendix) / Mod / 30-40



The carryback table identifies the assignment items which are new in this edition and those which are carried over from the seventh edition. For the latter, the problem number in the seventh edition is shown.

New Problem Number / Source / New Problem Number / Source / New Problem Number / Source
Q1.1 / Q1.1 / E1.1 / E1.1 / P1.1 / P1.1
Q1.2 / Q1.2 / E1.2 / E1.2 / P1.2 / P1.31
Q1.3 / Q1.9 / E1.3 / E1.41 / P1.3 / P1.51
Q1.4 / new / E1.4 / E1.61 / P1.4 / P1.81
Q1.5 / new / E1.5 / E1.71 / P1.5 / new
Q1.6 / Q1.12 / E1.6 / E1.91 / P1.6 / new
Q1.7 / Q1.5 / E1.7 / new / P1.7 / P1.111
Q1.8 / Q1.8 / E1.8 / new / P1.8 / P1.10
Q1.9 / new / E1.9 / E1.11 / P1.9 / new
Q1.10 / new / E1.10 / E1.12 / P1.10 / new
Q1.11 / Q1.7 / E1.11 / E1.3 / P1.11 / P1.4
Q1.12 / Q1.11 / E1.12 / E1.5 / P1.12 / P1.121

1 Revised for requirements of SFAS 141 and 142

Carryforward tables for all chapters, identifying the disposition of seventh edition assignment items, appear at the beginning of the solutions manual.




By structuring a business combination as a stock acquisition, the separate identity of the acquired company is maintained. It continues to be a separate legal entity and to maintain its own financial records. This may be advantageous should the acquirer subsequently wish to resell the company. Also, an acquisition of less than 100 percent ownership can be accommodated in the form of a stock acquisition, but not in other forms.


In contrast to the conglomerate movement of the 1960's, acquisitions in the 1990's appear to have a more strategic purpose. Also, many divestitures of unrelated businesses are occurring, reversing the trend toward diversification. In contrast to the debt-financed takeover movement of the 1980's, acquisitions in the 1990's are more often financed by equity.


In a combination recorded as a pooling of interests, it doesn't really matter, since the book values of the two companies are combined. In a combination recorded as a purchase, the acquiring company's assets and liabilities are unchanged, while the acquired company's assets and liabilities are recorded at fair values. In this case, the final result will be affected according to which company is designated the acquired company.


Allocating purchase premium to previously unrecorded but identifiable intangible assets gives a better accounting for the price paid to acquire a company. Purchase price often far exceeds the value of net tangible assets. In the past, very large percentages of the purchase price were often attributed to goodwill. By attributing amounts to identifiable intangibles, readers of financial statements can better understand the nature of the acquisition. Further, most identifiable intangible (other than those having indefinite life) will be amortized, while goodwill will not be amortized. Thus, future income measures are affected by attributing cost to identifiable intangibles rather than goodwill.


Attributing cost to the many intangibles acquired in a business combination is very difficult. The usual approach to doing so is to estimate the stand-alone value of the particular intangible. Such estimates are reasonably possible for those intangibles that are capable of being sold (Aseparable@), as one could estimate the prospective sales price. Such estimates are also reasonably possible for those intangibles that derive from legal and contractual rights, as one could estimate the value of having that legal/contractual right versus not having it. It would be much more difficult to estimate a stand-alone value for intangibles that have neither of these characteristics. Thus, these criteria were established to require allocation of acquisition cost to those intangibles that can reasonably be valued separately, and to not require allocation to those intangibles where such valuation is difficult.


An asset signifies something that has future value to the firm. Thus, goodwill should represent values such as brand names, customer base, experienced workforce, etc. It is possible, especially in a merger following a "bidding war," that the price paid to acquire a firm is too high, exceeding its value. If so, recording the excess purchase price as an asset would be inappropriate. However, we have no reliable ways of measuring firm value, so excessive goodwill cannot be readily detected.


Negative goodwill arises because of a disagreement between the fair values of identifiable assets and liabilities acquired and the investment cost. The Board decided to allocate the difference among those assets having the most subjective fair value estimates. The fair values of current assets, current liabilities, noncurrent liabilities and longterm investments in marketable securities are generally susceptible to objective measurement. This leaves other noncurrent assets, such as plant assets and identifiable intangibles, whose fair values are often highly uncertain, to be the "dumping ground" for negative goodwill.


A rise in interest rates is the most likely explanation for the decline in the market value of the bonds. The bonds originally issued are now worth less and, if the combination has occurred at the end of the contingency period, the original issue of debt would have been inadequate. More bonds having sufficient current market value to restore (not improve) the economic position of the acquired company's former shareholders must now be issued. The par value of the new bonds issued represents a discount on the entire bond issue which will be amortized over the remaining life of the bonds. A debit to Discount on Bonds Payable and a credit to Bonds Payable for the par value of the new debt on the books of the acquiring company will achieve this result. This has the effect of reducing both the old and new bonds issued to their current value at the date the contingency is resolved, an amount equal to the original cost of the acquired company. We conclude that this accounting treatment is sound.


Periodic amortization allocates the cost of a long-lived asset, less any expected residual value, systematically over its estimated life, so that some portion of its cost is deemed to be consumed each year. Under an impairment approach, no consumption of cost is measured until such time as a marked decline in the future benefit of the asset occurs. Periodic amortization seems appropriate in cases where useful life is known to be limited and where asset values generally decline with age; examples include equipment, vehicles, and patent rights. Impairment testing seems to be appropriate in cases where useful life can be very long and where asset values do not necessarily decline with age; examples include buildings and goodwill.


The reporting unit concept suggests that most companies are made up of a number of subunits. This feature has long been a part of segment reporting by companies. Reporting units are defined as subunits that by themselves constitute a business and have their operating results reviewed by company management; hence, internally, these units have reporting responsibility. Goodwill arising from a business combination is deemed to attach to specific business subunits (reporting units), either newly acquired reporting units or existing reporting units whose operations are enhanced by the acquisition. Subsequent accounting for goodwill, in the form of impairment testing, is carried out at the reporting unit level, not at the total firm level.


Q1.11 (Appendix)

The pooling concept views a business combination as the union of two previously independent ownership interests. No new economic resources are created nor are additional economic costs incurred. After the "union," there is no reason for combined stockholders' equity to differ from the sum of the previously separate stockholders' equities in the combining corporations. The accounting rules are designed to achieve this result. Since the par value of the stock issued by the "acquiring" company must be recorded, if the "acquired" company's total contributed capital is more (less) than this par value, the difference is credited (debited) to additional paid in capital (APIC). The retained earnings of the acquired company are wholly recorded in the combination unless a charge to APIC is required which exceeds the balance in the acquiring company's APIC account. In this case, the excess is debited to retained earnings. After the pooling, the combined amounts of the individual stockholders' equity accounts will normally differ from the sums of their individual balances but total combined stockholders' equity will equal the sum of the total stockholders' equities of the companies.

Q1.12 (Appendix)

The combining of two previously separate companies can in no way create additional prior earnings, so an increase in retained earnings could not be logical. The additional shares issued in a combination, however, could exceed prior invested capital, thus "capitalizing" some retained earnings. This is similar to the accounting for a stock dividend, where retained earnings may be reduced via an increase in the invested capital accounts.




Requirement 1:

Cash and Receivables / 120,000
Marketable Debt Securities / 150,000
Inventory / 800,000
Plant Assets, net / 2,000,000
Goodwill / 300,000
LongTerm Debt / 850,000
Current Liabilities / 340,000
Accrued Pension Liability / 130,000
Cash / 2,050,000

To record the merger with Sack Company as a purchase.

The attorney's fees of $50,000 are reflected in the credit

of cash of $2,050,000 and are part of the cost of the merger.

Requirement 2:

Investment in Sack / 2,050,000
Cash / 2,050,000

To record acquisition of Sack's shares as a stock

acquisition under the purchase method.



Requirement 1:

Allenhurst Corp.

Post-combination Balance Sheet

May 1, 20X4

Case (a) / Case (b) / Case (c)
Cash / $ 150,000 / $ 100,000 / $ 150,000
Other Current Assets / 750,000 / 600,000 / 750,000
Property Plant & Equipment / 1,600,000 / 1,200,000 / 1,600,000
Investment in Bensonhurst / -- / 300,000 / --
Goodwill / 50,000 / B / 50,000
$2,550,000 / $2,200,000 / $2,550,000
Current Liabilities / $ 400,000 / $ 300,000 / $ 400,000
Long-term Liabilities / 850,000 / 600,000 / 850,000
Common Stock / 200,000 / 200,000 / 200,000
Additional Paid-in Capital / 300,000 / 300,000 / 300,000
Retained Earnings / 800,000 / 800,000 / 800,000
$2,550,000 / $2,200,000 / $2,550,000

Requirement 2:

In the stock acquisition case, total assets are unchanged from Allenhurst's pre-combination balance sheet, reflecting the payment of $300,000 cash and the acquisition of a $300,000 stock investment. In the merger and asset acquisition cases, total assets increase by $350,000. Cash of $300,000 was paid to acquire assets recorded at $650,000 (including $50,000 of goodwill). Note that $350,000 in liabilities were also recorded, so that there was no change in Allenhurst's net assets.


E1.2 (cont=d.)

Requirement 3:

Bensonhurst Corp.

Balance Sheet

May 1, 20X4

Cash / $300,000 / Common Stock / $100,000
Additional Paid-in Capital / 50,000
Retained Earnings / 150,000
$300,000 / $300,000

Bensonhurst's only asset is $300,000 cash, received in exchange for all its previous assets and liabilities. The assets and liabilities sold had a net book value of $250,000. The $50,000 gain on the sale is reflected in retained earnings.


Requirement 1:

This transaction is an asset acquisition; a business unit is being acquired from Kraft, not a separate company.

Requirement 2:

The major tangible assets acquired by Unilever would be the production and distribution facilities and probably some inventories. Intangible assets are likely to be a major factor in this transaction. Unilever acquired two well-known brand names, plus an existing distribution/customer base that was the largest in the U.S. In combination with its existing brand names, this would be expected to give Unilever a significant share of the U.S. ice cream market.



Noncurrent Assets of
Scott Corp. / Fair Value / Book Value / (FVBV)
Land / $720,000 / $ 240,000 / $480,000
Buildings, net / 660,000 / 570,000 / 90,000
Equipment, net / 180,000 / 200,000 / (20,000)
Investment in Ace Corp. / 60,000 / 70,000 / (10,000)
$1,620,000 / $1,080,000 / $540,000
Negative Goodwill / (300,000)
Total purchase premium / $240,000

Negative goodwill must be allocated among noncurrent assets, including investments accounted for via the equity method, in accordance with their relative fair values. This is accomplished below, in the second stage of the twostage allocation process.

Noncurrent Asset / (1)
Fair Value
Amount / (2)
Fair Value
Percent / Allocation of Neg. Goodwill (3) (2)x$300,000 / Recorded Amount (1)(3)
Land / $ 720,000 / 44.5% / $133,500 / $ 586,500
Buildings, net / 660,000 / 40.7% / 122,100 / 537,900
Equipment, net / 180,000 / 11.1% / 33,300 / 146,700
Investment in Ace Corporation / 60,000 / 3.7% / 11,100 / 48,900
$1,620,000 / 100% / $300,000 / $1,320,000

Note:The above allocations of negative goodwill reflect rounding of the

relative fair value percentage to the nearest tenth of a percent.

E1.4 (cont=d.)

The following journal entry is made by Paper Company to record the

purchase (not required).

Other Assets / 1,180,000
Land / 586,500
Buildings / 537,900
Equipment / 146,700
Investment in Ace Corp. / 48,900
Cash / 2,500,000

To record the purchase of the net assets of Scott

Corporation for $2,500,000 cash.


Account / Case 1 / Case 2 / Case 3 / Case 4
Current Assets / $600,000 / $800,000 / $900,000 / $1,430,000
Land / 300,000 / 350,000(1) / 150,000(2) / --
Other PlantAssets / 700,000 / 350,000(1) / 450,000(2) / --
Goodwill / 200,000
Liabilities / (800,000) / (500,000) / (500,000) / (300,000)
Extraordinary Gain / (130,000)(3)

(1)Negative goodwill of $100,000 (= $1,100,000 $1,000,000) is allocated among Land and Other Plant Assets in accordance with their relative fair values, as follows:

Noncurrent Asset / (1)
Fair Value
Amount / (2)
Fair Value
Percent / Allocation of Neg. Goodwill (3) (2)x$100,000 / Recorded Amount (1)(3)
Land / $ 400,000 / 50% / $ 50,000 / $ 350,000
Other Plant Assets / 400,000 / 50% / 50,000 / 350,000
$ 800,000 / 100% / $100,000 / $700,000


E1.5 (cont=d.)

(2)Negative goodwill of $200,000 (=$1,200,000$1,000,000) is allocated among Land and Other Plant Assets in accordance with their relative fair values, as follows:

Land: $200,000 (200/800) $200,000 = $150,000

Other Plant Assets: $600,000 = (600/800) $200,000 = $450,000

(3)Negative goodwill of $380,000 (=$1,380,000 $1,000,000) is allocated to Land and Other Plant Assets, driving their combined fair value of $250,000 to zero. The resulting unallocated negative goodwill of $130,000 (=$380,000 ($50,000 + $200,000)) is reported as an extraordinary gain in the year of acquisition.


Requirement 1:

Primerica acquired 39.15 million shares (145 million x 27%) for $723 million. Thus the price per share was about $18.50 (723/39.15).

Requirement 2:

Travelers stockholders will receive .8 Primerica share which is worth $37.60 ($47 x .8). Since Travelers is currently trading at $36, the premium is $1.60 or about 4 percent. Note, however, that Travelers stock appears to have almost doubled in price over the past year, as the original acquisition was at $18.50, which was certainly no less than the market price at that time.

Requirement 3:

Cost of initial acquisition / $ 723,000,000
Cost of second acquisition
145 million shares x .73 acquired x $47 value of Primerica shares exchanged x .8 exchange ratio / 3,980,000,000



Because the acquisition date is designated as a date prior to the completion of the combination, interest expense must be accrued from the designated acquisition date to the date of combination.

Interest to be accrued = $20,000,000 X .10 X (25/365) = $136,986

Entries to record acquisition:

Investment in Smith / 20,000,000
Cash / 20,000,000

To record acquisition of Smith Corporation for cash.

Interest Expense / 136,986
Investment in Smith / 136,986

To accrue interest for 25 days from designated

acquisition date to combination date.


Identifiable intangibles are to be recorded in a business combination. Identifiable intangibles include those arising from contractual and other legal rights and those which are separable.

Of the eight intangibles listed, four appear to be based on contractual and other legal rights:

Signed customer contracts / $1,000,000
Internet domain name / 150,000
Office leases / 100,000
Registered company name and trademark / 60,000


E1.8 (cont=d.)

One additional item appears to be separable, capable of being sold, licensed, or otherwise transferred:

Databases of industry data / $ 50,000

The remaining three items appear to be neither based on contractual/legal rights or separable.

DeLight would account for the $2,000,000 purchase premium by allocating $1,360,000 to the five identifiable intangibles identified above, and the remaining $640,000 would be allocated to goodwill.


1/3/X7 / 12/31/X7 / 12/31/X8
Current Assets / $ 850,000 / $ 850,000 / $ 850,000
Noncurrent Assets / 1,600,000 / 1,600,000 / 1,600,000
Goodwill / 130,000 / 50,000 (1) / 50,000 (2)
Monetary Liabilities / (500,000) / (500,000) / (500,000)
Estimated Liability / (280,000) / (200,000)(1) / (350,000)(2)

(1)Since the favorable new information was received within the 12month allocation period, the original purchase price allocation is revised with both the Estimated Liability and Goodwill being reduced by $80,000.