CHAPTER 2

Note: The letter A indicated for a question, exercise, or problem means that the question, exercise, or
problem relates to a chapter appendix.

ANSWERS TO QUESTIONS

2-1
 ANSWERS TO EXERCISES

Exercise 2-1

A. Receivables 228,000
Inventory 396,000
Plant and Equipment 540,000
Land 660,000
Goodwill ($1,560,000 - $1,230,000) 330,000
Liabilities 594,000
Cash 1,560,00
0
B. Receivables 228,000
Inventory 396,000
Plant and Equipment 540,000
Land 660,000
Liabilities 594,000
Cash 990,000
Gain on Business Combination ($1,230,000 - $990,000) 240,000

2-2
Exercise 2-2

Cash $680,000
Receivables 720,000
Inventories 2,240,000
Plant and Equipment (net) ($3,840,000 + $720,000) 4,560,000
Goodwill 120,000
Total Assets $8,320,000

Liabilities 1,520,000
Common Stock, $16 par ($3,440,000 + (.50  $800,000)) 3,840,000
Other Contributed Capital ($400,000 + $800,000) 1,200,000
Retained Earnings 1,760,000
Total Equities $8,320,000

The entry on Petrello Company’s books would be:

Cash 200,000
Receivables 240,000
Inventory 240,000
Plant and Equipment 720,000
Goodwill * 120,000
Liabilities 320,000
Common Stock (25,000  $16) 400,000
Other Contributed Capital ($48 - $16)  25,000 800,000

* ($48  25,000) – [($1,480,000 – ($800,000 – $720,000) – $320,000]

= $1,200,000 – [$1,480,000 – $80,000 – $320,000] = $1,200,000 – $1,080,000 =
$120,000

2-3
 Exercise 2-3

Accounts Receivable 231,000

Inventory 330,000
Land 550,000
Buildings and Equipment 1,144,000
Goodwill* 848,000
Allowance for Uncollectible Accounts ($231,000 - $198,000) 33,000
Current Liabilities 275,000
Bonds Payable 450,000
Premium on Bonds Payable ($495,000 - $450,000) 45,000
Preferred Stock (15,000$100) 1,500,000
Common Stock (30,000$10) 300,000
Other Contributed Capital ($25 - $10) 30,000 450,000
Cash 50,000

* Calculation of goodwill:
Cost paid ($1,500,000 + $750,000 + $50,000) $2,300,000
Fair value of net assets (198,000 + 330,000 + 550,000 + 1,144,000 – 275,000 – 495,000) 1,452,000
Goodwill $848,000

Exercise 2-4

Cash 96,000
Receivables 55,200
Inventory 126,000
Land 198,000
Plant and Equipment 466,800
Goodwill* 137,450
Accounts Payable 44,400
Bonds Payable 480,000
Premium on Bonds Payable** 45,050
Cash 510,000

** Present value of maturity value, 12 periods @ 4%: 0.6246$480,000 = $299,808

Present value of interest annuity, 12 periods @ 4%: 9.38507$24,000 = 225,242
Total present value 525,050
Par value 480,000
Premium on bonds payable $ 45,050
*Cash paid $510,000
Less: Book value of net assets acquired ($897,600 – $44,400 – $480,000) (373,200)
Excess of cash paid over book value 136,800
Increase in inventory to fair value (15,600)
Increase in land to fair value (28,800)
Increase in bond to fair value 45,050
Total increase in net assets to fair value 650
Goodwill $137,450

2-4
Exercise 2-5

A. Current Assets 960,000

Plant and Equipment 1,440,000
Goodwill 120,000
Liabilities 216,000
Cash 2,160,000
Liability for Contingent Consideration 144,000

B. Loss on change in Fair Value of Contingent Consideration 56,000

Liability for Contingent Consideration 56,000

C. Liability for Contingent Consideration 200,000

Gain on change in Fair Value of Contingent Consideration 200,000

Exercise 2-6

A. Current Assets 960,000

Plant and Equipment 1,440,000
Goodwill 176,000
Liabilities 216,000
Cash 2,160,000
Liability for Contingent Consideration 200,000

B. Liability for Contingent Consideration 200,000

Common Stock ($10 × 10,000) 100,000
Paid in Capital – Common Stock 100,000

Note: Platz Company does not adjust the original amount recorded as equity.

Exercise 2-7

1. (c) Cost (8,000 shares @ $30) $240,000

Fair value of net assets acquired 228,800
Excess of cost over fair value (goodwill) $ 11,200

2. (c) Cost (8,000 shares @ $30) $240,000

Fair value of net assets acquired ($90,000 + $242,000 – $56,000) 276,000
Excess of fair value over cost (gain) $ 36,000

Exercise 2-8

Current Assets 362,000

Long-term Assets ($1,890,000 + $20,000) + ($98,000 + $5,000) 2,013,00
0
Goodwill * 395,000
2-5
 Liabilities 119,000
Long-term Debt 491,000
Common Stock (144,000  $5) 720,000
Other Contributed Capital (144,000 $15 - $5)) 1,440,000

* (144,000 $15) – [$362,000 + $2,013,000 – ($119,000 + $491,000)] = $395,000

 $700,000 $20 ,000 

Total shares issued    = 144,000
 $5 $5 
Fair value of stock issued (144,000$15) = $2,160,000

Exercise 2-9
Case A:
Cost (Purchase Price) $130,000
Less: Fair Value of Net Assets 120,000
Goodwill $ 10,000
Case B:
Cost (Purchase Price) $110,000
Less: Fair Value of Net Assets 90,000
Goodwill $ 20,000
Case C:
Cost (Purchase Price) $15,000
Less: Fair Value of Net Assets 20,000
Gain ($ 5,000)

Assets
Liabilities Retained
Goodwill Current Assets Long-Lived Assets
Earnings (Gain)
Case A $10,000 $20,000 $130,000 $30,000 $ 0
Case B 20,000 30,000 80,000 20,000 0
Case C 0 20,000 40,000 40,000 5,000

2-6
Exercise 2-10

A. Goodwill impairment tests:

2014: Step 1: Fair value of the reporting unit $400,000
Carrying value of unit:
Carrying value of identifiable net assets $330,000
Carrying value of goodwill ($450,000 - $375,000) 75,000
405,000
Excess of carrying value over fair value $ 5,000

The excess of carrying value over fair value means that step 2 is required.

Step 2: Fair value of the reporting unit $400,000

Fair value of identifiable net assets 340,000
Implied value of goodwill 60,000
Recorded value of goodwill ($450,000 - $375,000) 75,000
Impairment loss $ 15,000

2015: Step 1: Fair value of the reporting unit $400,000

Carrying value of unit:
Carrying value of identifiable net assets $320,000
Carrying value of goodwill ($75,000 - $15,000) 60,000
380,000
Excess of fair value over carrying value $ 20,000

The excess of fair value over carrying value means that step 2 is not required.

2016: Step 1: Fair value of the reporting unit $350,000

Carrying value of unit:
Carrying value of identifiable net assets $300,000
Carrying value of goodwill ($75,000 - $15,000) 60,000
360,000
Excess of carrying value over fair value $ 10,000

The excess of carrying value over fair value means that step 2 is required.

Step 2: Fair value of the reporting unit $350,000

Fair value of identifiable net assets 325,000
Implied value of goodwill 25,000
Recorded value of goodwill ($75,000 - $15,000) 60,000
Impairment loss $ 35,000

2-7
B. Journal entries to record impairment losses:

2014: Impairment Loss—Goodwill 15,000

Goodwill 15,000

2015: No entry

2016: Impairment Loss—Goodwill 35,000

Goodwill 35,000

C. SFAS No. 142 specifies the presentation of goodwill in the balance sheet and income statement
(if impairment occurs) as follows:
 The aggregate amount of goodwill should be a separate line item in the balance
sheet.
 The aggregate amount of losses from goodwill impairment should be shown as a
separate line item in the operating section of the income statement unless some of the
impairment is associated with a discontinued operation (in which case it is shown
net-of-tax in the discontinued operation section).

D. In a period in which an impairment loss occurs, SFAS No. 142 mandates the following
disclosures in the notes:
(1) A description of the facts and circumstances leading to the impairment;
(2) The amount of the impairment loss and the method of determining the fair value
of the reporting unit;
(3) The nature and amounts of any adjustments made to impairment estimates from
earlier periods, if significant.

Exercise 2-11

A. Fair Value of Identifiable Net Assets

Book values $500,000 – $100,000 $400,000
Write up of Inventory and Equipment:
($20,000 + $30,000) 50,000
Purchase price above which goodwill would result $450,000

B. Equipment would not be written down, regardless of the purchase price, unless it was reviewed
and determined to be overvalued originally.

C. A gain would be shown if the purchase price was below $450,000.

D. Anything below $450,000 is technically considered a bargain.

E. Goodwill would be $50,000 at a purchase price of $500,000 or ($450,000 + $50,000).

2-8
Exercise 2-12A

Cash 20,000
Accounts Receivable 112,000
Inventory 134,000
Land 55,000
Plant Assets 463,000
Discount on Bonds Payable 20,000
Goodwill* 127,200
Allowance for Uncollectible Accounts 10,000
Accounts Payable 54,000
Bonds Payable 200,000
Deferred Income Tax Liability 67,200
Cash 600,000

*Calculation of goodwill:
Acquisition cost $600,000
Book value of net assets acquired ($80,000 + $132,000 + $160,000) 372,000
Difference between cost and book value 228,000
Allocated to:
Increase inventory, land, and plant assets to fair value ($52,000 + $25,000 + $71,000) (148,000)
Decrease bonds payable to fair value (20,000)
Establish deferred income tax liability ($168,00040%) 67,200
Balance to goodwill $127,200

ANSWERS TO PROBLEMS

Problem 2-1

Current Assets 85,000

Plant and Equipment 150,000
Goodwill* 100,000
Liabilities 35,000
Common Stock [(20,000 shares @ $10/share)] 200,000
Other Contributed Capital [(20,000($15 – $10))] 100,000

Acquisition Costs Expense 20,000

Cash 20,000

Other Contributed Capital 6,000

Cash 6,000
To record the direct acquisition costs and stock issue costs

* Goodwill = Excess of Consideration of $335,000 (stock valued at $300,000 plus debt assumed of
$35,000) over Fair Value of Identifiable Assets of $235,000 (total assets of $225,000 plus PPE fair
value adjustment of $10,000)

2-9
Problem 2-2

A. Acme Company
Balance Sheet
October 1, 2011
(000)

Assets (except goodwill) ($3,900 + $9,000 + $1,300) $14,200

Goodwill* 1,160
Total Assets $15,360

Liabilities ($2,030 + $2,200 + $260) $4,490

Common Stock (180$20) + $2,000 5,600
Other Contributed Capital (180($50 – $20)) 5,400
Retained Earnings (130)
Total Liabilities and Equity $15,360

* Cost (180$50) $9,000

Fair value of net assets acquired:
Fair value of assets of Baltic and Colt $10,300
Less liabilities assumed 2,460 7,840
Goodwill $1,160

B.
Baltic
2015: Step 1: Fair value of the reporting unit $6,500,000
Carrying value of unit:
Carrying value of identifiable net assets $6,340,000
Carrying value of goodwill 200,000*
Total carrying value $6,540,000

*[(140,000 x $50) – ($9,000,000 – $2,200,000)]

The excess of carrying value over fair value means that step 2 is required.

Step 2: Fair value of the reporting unit $6,500,000

Fair value of identifiable net assets 6,350,000
Implied value of goodwill 150,000
Recorded value of goodwill 200,000
Impairment loss $ 50,000

($150,000 < $200,000)

Colt
2015: Step 1: Fair value of the reporting unit $1,900,000
Carrying value of unit:
Carrying value of identifiable net assets $1,200,000
Carrying value of goodwill 960,000*
Total carrying value $2,160,000

2 - 10
 *[(40,000 x $50) – ($1,300,000 – $260,000)]

The excess of carrying value over fair value means that step 2 is required.

Step 2: Fair value of the reporting unit $1,900,000

Fair value of identifiable net assets 1,000,000
Implied value of goodwill 900,000
Recorded value of goodwill 960,000
Impairment loss $ 60,000

($900,000 < $960,000)

Total impairment loss is $110,000.

Journal entry:
Impairment Loss 110,000
Goodwill 110,000

Problem 2-3
Present value of maturity value, 20 periods @ 6%: 0.3118$600,000 $187,080
Present value of interest annuity, 20 periods @ 6%: 11.46992$30,000 344,098
Total Present value 531,178
Par value 600,000
Discount on bonds payable $ 68,822

Cash 114,000
Accounts Receivable 135,000
Inventory 310,000
Land 315,000
Buildings 54,900
Equipment 39,450
Bond Discount ($40,000 + $68,822) 108,822
Current Liabilities 95,300
Bonds Payable ($300,000 + $600,000) 900,000
Gain on Purchase of Business* 81,872

*Excess of Net Assets Received Over Cost

Purchase Price ($531,178 + $95,300 + $260,000) $886,478
Less: Total fair value of assets received 968,350
Excess of fair value of net assets over cost ($ 81,872)

Problem 2-4
A. January 1, 2014:

Accounts Receivable 72,000

Inventory 99,000
Land 162,000
Buildings 450,000
2 - 11
Equipment 288,000
Goodwill* 19,000
Allowance for Uncollectible Accounts 7,000
Accounts Payable 83,000
Note Payable 180,000
Cash 720,000
Liability for Contingent Consideration 100,000

*Consideration paid ($720,000 + $100,000) $820,000

Total fair value of net assets acquired ($1,064,000 - $263,000) 801,000
Goodwill $ 19,000

2 - 12
Problem 2-4 (continued)

B. January 2, 2013:

Loss on Change in Fair Value of Contingent Consideration 20,000

Liability for Contingent Consideration 20,000

C. January 2, 2013:

Liability for Contingent Consideration 120,000

Gain from Change in Fair Value of Contingent Consideration 120,000

Problem 2-5
Pepper Company
Pro Forma Balance Sheet
Giving Effect to Proposed Issue of Common Stock and Note Payable for
All of the Common Stock of Salt Company under Purchase Accounting
December 31, 2013

Audited Pro Forma

Balance Sheet Adjustments Balance Sheet
Cash $ 180,000 405,000 $ 585,000
Receivables 230,000 (60,000) 287,000
117,000
Inventories 231,400 134,000 365,400
Plant Assets 1,236,500 905,000 (1) 2,141,500
Goodwill _________ 181,500 181,500
Total Assets $1,877,900 $3,560,400

Accounts Payable $ 255,900 (60,000) $ 375,900

180,000
Notes Payable, 8% 0 300,000 300,000
Mortgage Payable 180,000 152,500 332,500
Common Stock, $20 par 900,000 600,000 1,500,000
Additional Paid-in Capital 270,000 510,000 (2) 780,000
Retained Earnings 272,000 272,000
Total Liabilities and Equity $1,877,900 $3,560,400

2 - 13
Problem 2-5 (continued)

Change in Cash:
Cash from stock issue ($3730,000) $1,110,000
Less: Cash paid for acquisition (800,000)
Plus: Cash acquired in acquisition 95,000
Total change in cash $ 405,000

Goodwill:
Cost of acquisition $1,100,000
Net assets acquired ($340,000 + $179,500 + $184,000) 703,500
Excess cost over net assets acquired $396,500
Assigned to plant assets 215,000
Goodwill $ 181,500

(1) $690,000 + $215,000 (2) ($37- $20) 30,000

Problem 2-6
Ping Company
Pro Forma Income Statement for the Year 2014
Assuming a Merger of Ping Company and Spalding Company

Sales (1) $6,345,972

Cost of goods sold:
Fixed Costs (2) $ 824,706
Variable Costs (3) 2,464,095 3,288,801
Gross Margin 3,057,171

Selling Expenses (4) 785,910

Other Expenses (5) 319,310 1,105,220

Net Income $1,951,951

$1,951,951 – ($952,640 + $499,900) = $499,411 = $2,497,055

0.20 0.20
Since $2,497,055 is greater than $1,800,000 Ping should buy Spalding.

(1) $3,510,100 + $2,365,800 = $5,875,9001.2.9 = $6,345,972

(2) ($1,752,360.30) + ($1,423,800.30.70) = $824,706

$5,875,900  1.2
(3) $1,752,360.70 = $2,464,095
$3,510 ,100
(4) ($632,500 + $292,100).85 = $785,910

(5) $172,6001.85 = $319,310

2 - 14
Problem 2-7A

A. Receivables 125,000
Inventory 195,000
Land 120,000
Plant Assets 567,000
Patents 200,000
Deferred Tax Asset ($60,000 x 35%) 21,000
Goodwill* 154,775
Current Liabilities 89,500
Bonds Payable 300,000
Premium on Bonds Payable 60,000
Deferred Tax Liability 93,275
Common Stock (30,000$2) 60,000
Other Contributed Capital (30,000$26) 780,000

*Cost of acquisition (30,000$28) $840,000

Book value of net assets acquired ($120,000 + $164,000 + $267,000) 551,000
Difference between cost and book value 289,000
Allocated to:
Increase inventory, land, plant assets, and patents to fair value (266,500)
Deferred income tax liability (35%$266,500) 93,275
Increase bonds payable to fair value 60,000
Deferred income tax asset (35%$60,000) (21,000)
Balance assigned to goodwill $154,775

B. Income Tax Expense (Balancing amount) 148,006

Deferred Tax Liability ($51,12535%)* 17,894
Deferred Tax Asset ($6,00035%) 2,100
Income Tax Payable ($468,00035%) 163,800

* Inventory: $28,000
$100,000
Plant Assets, 10,000
10
$105,000
Patents, 13,125
8
Total $51,125

2 - 15