Chapter -4: Business of Combination

4.1 Business of Combination: An Overview

4.1.1 Definition of Business Combination
Business combinations are events or transactions in which two or more business enterprises, or
their net assets, are brought under common control in a single accounting entity. According to the
Financial Accounting Standards Board, a business combination is an event or a procedure, in
which, an entity acquires net assets that constitute a business or acquires equity interests of one
or more other entities and obtains control over that entity or entities ( SFAS No. 141). Commonly,
business combinations are often referred to as mergers and acquisitions.

Amalgamation - two or more firms may amalgamate, either by taking over or by the formation
of a new firm. A decision to amalgamate shall be taken by each of the firms concerned. Special
meetings of shareholders of different classes or meetings of debenture holders shall approve the
taking over or being taken over (Art.549 & 550, Commercial Code of Ethiopia)
The Financial Accounting Standards Board has suggested the following definitions for terms
used in business combinations:
1. Combined Enterprise: The accounting entity that results from a business combination.
2. Constituent Companies: The business enterprises that enter into a combination.
3. Combinor A constituent company entering into a combination whose owners as a
group ends up with control of the ownership interests in the combined enterprise.
4. Combinee a constituent company other than the combinor in a business combination.
The term acquired, acquiree and combinee can be used interchangeably.
The following are the assertions relating to business combinations as per SFAS No.141
1. Business combination is a transaction or other event in which an acquirer obtains control of
one or more businesses.
2. An acquirer can be identified in every business combination.
3. The business combination acquisition date is the date the acquirer obtains control of the
acquiree.
4. A business combination is accounted for by applying the acquisition method.
5. By obtaining control of an acquiree, an acquirer becomes responsible and accountable for all
of the acquiree's assets, liabilities, and activities, regardless of the percentage of its
ownership in the acquiree.
2.1.2 Classes of Business Combinations
Business combinations are classified into two classes based on nature: friendly takeovers and
unfriendly (hostile) takeovers.
Friendly Takeover
 The Board of Directors of all constituent companies amicably (friendly) determine the
terms of the business combination.
 The proposal is submitted to share holders of all constituent companies for approval.
Hostile Takeovers
In this type of takeovers, the target combinee typically resists the proposed business
combination. Thus, the target combinee uses one or more of the following defensive tactics.
1. Pac-man Defense: a threat to undertake in a hostile takeover of the prospective
combinor.
2. White Knight: a search for a candidate to be the combinor in a friendly takeover.
 3. Scorched Earth: the disposal of one or more business segments that attracts the
combinor. The profitable segment can be disposed through sale or spin-off.
This is sometimes called selling the crown jewels: The sale of valuable assets to
others to make the firm less attractive to the would-be acquirer. The negative aspect
is that the firm, if it survives, is left without some important assets
4. Shark Repellent: an acquisitions of substantial amounts of outstanding common
stock for the treasury or for retirement, or the incurring of substantial long-term debt
in exchange for outstanding common stock.
5. Poison Pill: an amendment of the articles of incorporation or bylaws to make it more
difficult to obtain stockholder approval for a takeover.
6. Greenmail: an acquisition of common stock presently owned by the prospective
combinor at a price substantially in excess of the prospective combinor's cost, with
the stock thus acquired placed in the treasury or retired

4.1.3 Types of Business Combinations

There are three types of business combinations: Horizontal Combination, Vertical Combination,
and Conglomerate Combination:
1. Horizontal Combination: is a combination involving enterprises in the same industry.
E.g. assume combination of BEDELE Brewery and HARAR Brewery
2. Vertical Combination: A Combination involving an enterprise and its customers or
suppliers. It is a combination involving companies engaged in different stages of
production or distribution. It is classified into two: Backward Vertical Combination -
combination with supplier and Forward Vertical Combination - combination with
customers. E.g.1: A Tannery Company acquiring a Shoes Company - Forward
E.g.2: Weaving Company acquiring both Ginning and Spinning Company - Backward
3. Conglomerate (Mixed) Combination: is a combination involving companies that are
neither horizontally nor vertically integrated. It is a combination between enterprises in
unrelated industries or markets.
Antitrust Considerations
Antitrust litigations are one obstacle faced by large corporations that undertake business
combinations. A business combination that leads to lessen the competition or tend to create a
monopoly is not allowed by the government. Government on occasion has opposed
concentration of economic power in large business enterprises as the formation of monopoly
discourages competition. Antitrust is a law that encourages perfect competition and discourages
monopoly. Business combinations may lead to formation of monopoly so that they are
challenged department of government. The type of combination determines the degree of
concentration of economic power. Horizontal combinations create the largest concentration of
economic power and play a negative role in discouraging competition than the other two types of
business combinations.
4.2 Business Combinations: Why?
Why do business enterprises enter into a business combination? There are a number of reasons
for business combinations which are discussed as follows:
1. Growth
In recent years Growth has been main reason for business enterprises to enter into a business
combination. Firms can achieve growth through external and internal methods.
The external (e.g. business combination) method of achieving growth is more rapid than growth
through internal methods, as per advocates of external method.
There is no question that expansion and diversification of product lines, or enlarging the market
share for current products, is achieved readily through a business combination with another
enterprise. Combinations enable satisfactory and balanced growth of an enterprise. The company
can cross many stages of growth at one time through combination. Growth through combination
is also cheaper and less risky. By acquiring other enterprises, a desired level of growth can be
maintained by an enterprise. When an enterprise tries to enter new line of activities, it may face a
number of problems in production, marketing, purchasing. Business combination enables to
acquire or merge with an enterprise already operating indifferent lines that have crossed many
obstacles and difficulties. Combination will bring together experiences of different persons in
varied activities. So combination will be the best way of Growth.

2. Economies of Scale
A combined enterprise will have more resources at its command than the individual enterprises.
This will help in increasing the scale of operations so that economies of large scale will be
availed. The economies of scale will occur as a result of more intensive utilization of production
facilities, distribution network, research and development facilities, etc. The economies of scale
will lead to financial synergies.

3. Operating Economies
A number of operating economies will be available with the combination of two or more
enterprises. Duplicating facilities in accounting, purchasing, marketing, etc will be eliminated.
Operating inefficiencies of small concerns will be controlled by superior management emerging
from the combinations. The acquiring company will be in a better position to operate than the
acquired companies individually. Whether the horizontal or vertical business combinations, it
may provide operating synergies when the duplicated facilities are eliminated

4. Better Management
Combinations results in better management. Combinations result running the large scale
enterprises. A large enterprise can offer to use the service of expertise. Various managerial
functions can be efficiently managed by those persons who are qualified for such jobs. This is
not possible for small individual enterprises.

5. Monopolistic Ambitions
One of the important reasons behind business combination is monopolistic ambitions. The
combined enterprises try to control more and more enterprises in the same line so that they may
be able to detect their terms (E.g. set their price). But, the antitrust law is against such type of
business combination.

6. Diversification of Business Risk

When one company involves business combination, it can diversify risks of operations. A
Company involving business combination can minimize risks as the enterprise is diversifying
operation or line of their activity. Since different companies are already dealing in their
respective lines, there will be risk diversification.
7. Tax Advantages
When an enterprise with accumulated losses merges with a profit making enterprise, it is able to
utilize tax shields (benefits). An enterprise having losses will not be able to set-off losses against
future profits, because it is not a profit earning unit. On the other hand, if it merges with an
enterprise earning profits then the accumulated losses of one unit will be set-off against future
profit of the other unit. In this way, combinations will enable an enterprise to avail tax benefits.
The tax law that permits setting off losses is either Loss Carry Forward or Loss Carry Back.

8. Elimination of Fierce Competition

Combination of two or more enterprises will eliminate competition among them. The enterprises
will be able to save their advertising expenses. This enables the combined enterprise to reduce
prices. The consumer will also benefit in the form cheaper goods being made available to them.

9. Better Financial Planning

A combined enterprise will be able to plan their resources in a better way. The collective finance
of merged enterprises will be more and their utilization may be better than in separate
enterprises. It may happen that one of the merging enterprises has short Gestation period (A
period of time from making investment to collecting the returns) while the other has longer
Gestation period. The profits with short gestation period will be utilized to finance the other
enterprise with long gestation period. When the enterprise with longer gestation period starts
earning profits then it will improve financial position as a whole.

10. Getting financial gains

Critics have alleged that the foregoing reasons attributed to the "urge to merge" (business
combinations) do not apply to unfriendly takeovers. These critics complain that the "Sharks"
who engage in unfriendly takeovers need financial benefits after assessing the prospect of
substantial gains resulting from the sale of business segments of a combine following the
business combination.

4.3 Methods for Arranging Business Combinations

The four common methods for carrying out a business combination are:
5. Statutory Merger
6. Statutory Consolidation,
7. Acquisition of Common Stock, and
8. Acquisition of Assets

. Statutory Merger
Statutory Merger is a merger in which one of the merging companies continues to exist as a legal
entity while the other or other are dissolved. A business combination in which one company (the
survivor) acquires all the outstanding common stock of one or more other companies that are
then dissolved and liquidated, with their net assets owned by the survivor. The survivor can
effect the transaction by exchanging voting common stock or preferred stock, cash, or long-term
debt ( or a combination of these) for all of the outstanding voting common stock of the acquired
company or companies. It is executed under provisions of applicable state laws. The boards of
directors of the constituent companies normally negotiate the terms of a plan of merger, which
must then be approved by the stockholders of each company involved.
 In a statutory merger, one or more of the combinee companies are liquidated and thus cease to
exist as separate legal entities, and their activities often are continued as divisions of the survivor,
which now owns the net assets (assets minus liabilities), rather than the outstanding common
stock, of the liquidated corporations.
E.g. ABC Company acquires all the outstanding common stock (net assets) of XYZ Company
where XYZ Company is legally liquidated
. Statutory Consolidation
is a business combination in which a new corporation issues common stock
Statutory Consolidation
for all outstanding common stock of two or more other corporations that are then dissolved and
liquidated, with their net assets owned by the new corporation. It is a in which a new corporate
entity is created from the two or more merging companies, which cease to exist. It differs from
statutory merger, in which one survives as a The combination of Chrysler Corporation and
Daimler-Benz to form DaimlerChrysler is an example of this type of consolidation.
E.g. ABC Company acquires XYZ Company; but a new Company AYZ is created to
issue common stocks for the two companies which are now defunct.
. Acquisition of Common Stock
One corporation (the investor) may issue preferred or common stock, cash, debt, or a
combination thereof to acquire a controlling interest in the voting common stock of another
corporation (the investee). This stock acquisition program may be accomplished through direct
acquisition in the stock market, through negotiations with the principal stockholders of a closely
held corporation or through a tender offer to stockholders of a publicly owned corporation. A
tender offer is a publicly announced intention to acquire, for a stated amount of consideration, a
maximum number of shares of the combinee's common stock "tendered" by holders thereof to an
agent, such as an investment banker or a commercial bank. The price per share stated in the
tender offer usually is well above the prevailing market price of the combinee's common stock. If
a controlling interest in the combinee's voting common stock is acquired, that corporation
becomes affiliated with the combinor (parent company) as a subsidiary but is not dissolved and
liquidated and remains a separate legal entity. The business combination through this method
requires authorization by the combinor's board of directors and may require ratification by the
combinee's stockholders. Most hostile takeovers are accomplished by this means.

E.g. ABC Company acquires over 50% of the voting stock of XYZ Company, a parent-
subsidiary relationship results and XYZ Company is now a subsidiary of ABC Company
(Parent)
. Acquisition of Assets
A business enterprise may acquire all or most of the gross assets or net assets of another
enterprise for cash, debt, preferred or common stock, or a combination thereof. The transaction
generally must be approved by the boards of directors and stockholders of the constituent
companies. The selling enterprise may continue its existence as a separate entity or it may be
dissolved and liquidated; it does not become an affiliate of the combinor.
 Summary of Methods for Arranging Business Combinations

Type of Combination Action of Acquiring Company Action of Acquired Company

Statutory
Merger Acquires all stock or net assets Dissolves & goes out of business. It
and then transfers assets & may also remain as separate division
liabilities to its own books. of the acquiring company
Statutory
Consolidation Newly created to receive assets Both original companies may dissolve
or capital stock of original while remaining as separate divisions
companies of newly created company.

Acquisition of
Common Stock Acquires more than 50% stock Remains in existence as legal
that is recorded as an investment. corporation, although now a
Controls decision making of subsidiary of the acquiring company.
acquired company.
Acquisition of
Assets Acquires all or most of the gross The acquiree company may remain in
assets existence or may be liquidated but not
a subsidiary of the acquiring

company

The last two methods for carrying out a business combination, the combinor issues its common stock,
cash, debt, or a combination thereof, to acquire the common stock or the net assets of the combinee.
These two methods do not involve the liquidation of the combinee.

2.4) Determination of the Price for a Business Combination

Establishing the price for a business combination is a very important early step in planning a
business combination. The price for a business combination consummated for cash or debt
generally is expressed in terms of the total dollar amount of the consideration issued. When
common stock is issued by the combinor in a business combination, the price is expressed as a
ratio of the number of shares of the combinor's common stock to be exchanged for each share of
the combinee's common stock
Illustration of Exchange Ratio The negotiating officers of Palmer Corporation have agreed
with the shareholders of Simpson Company to acquire all 20,000 outstanding shares of Simpson
common stock for a total price of Br 1,800,000. Palmer's common stock presently is trading in
the market at Br 65 a share. Stockholders of Simpson agree to accept 30,000 shares of Palmer's
common stock at a value of Br 60 a share in exchange for their stock holdings in Simpson. The
exchange ratio is expressed as 1.5 shares of Palmer's common stock for each share of Simpson's
common stock, in accordance with the following computation:
Number of shares of Palm corporation common stock to be issued.............. 30,000
Number of shares of Simpson company stock to be exchanged....................20,000
Exchange ratio: 30,000 / 20,000.................................................................... 1.5:1
The amount of cash or debt securities, or the number of shares of common or preferred stock, to
be issued in a business combination generally is determined by variations of two methods:
2.5) Accounting Methods for Business Combinations
There were two methods of accounting for business combinations: Pooling-of-Interest and
Purchase Method. Some business combinations were accounted for under Pooling-of-Interest
while some business combinations were accounted for under purchase accounting method, in the
past.

1. Pooling-of-Interest Accounting
The original premise of the pooling-of-interests method was that certain business combinations
involving the issuance of common stock between an issuer and the stockholders of a
combinee were more in the nature of a combining of existing stockholder interests than an
acquisition of assets or raising of capital. Combining of existing stockholder interests was
evidenced by combinations involving common stock exchanges between corporations of
approximately equal size. The shareholders and managements of these corporations continued
their relative interests and activities in the combined enterprise as they previously did in the
constituent companies. Because neither of the like-size constituent companies could be
considered the combinor under the criteria set forth to determine combinor, the pooling-of-
interests method of accounting provided for carrying forward to the accounting records of the
combined enterprise the combined assets, liabilities, and retained earnings of the constituent
companies at their carrying amounts in the accounting records of the constituent companies. The
current fair value of the common stock issued to effect the business combination and the current
fair value of the combinee's net assets are disregarded in a pooling of interests Under Pooling-of-
Interest (Uniting Interest) accounting method, the balance sheet items of the two companies are
simply added together. Pooling of interests was the preferable method to use because it doesn't
result in the creation of goodwill. This in turn leads to higher reported earnings. Pooling of
interests required the following 12 criteria to be met:

Attributes of the Combining Companies

1. Autonomous (two-year rule)
2. Independent (10% rule)
Manner of Combining Interest
3. Single transaction (completed in one year following the initiation)
4. Exchange of common stock (90% "substantially all" rule)
5. No equity changes in contemplation of combination (two-year rule)
6. Shares reacquired only for purposes other than combination
7. No change in proportionate equity interests
8. Voting rights immediately exercisable
9. Combination resolved at consummation (no pending provisions)
Absence of Planned Transactions
10. Issuing company does not agree to reacquire shares
11. Issuing company does not make deals to benefit former stockholders
12. Issuing company does not plan to dispose of assets within two years
Using the pooling-of-interests method, companies could add together the book values of their net
assets without indicating which entity was the "purchaser" and which was the "purchased." When
this method was used, investors often had difficulty identifying who was buying whom or
determining how to evaluate the transactions. Thus, FASB ruled out Pooling-of-Interests through
FASB Statement No. 141 in 2001 for new business combinations. FASB unanimously voted to
eliminate pooling of interests as an acceptable method of accounting for business combinations.

2. Purchase Accounting
Because the majority of business combinations involve an identified combinor and one or more
combinees, many accountants consider it logical to account for business combinations, regardless of how
consummated, as the acquisition of assets. Thus, assets (including goodwill) acquired in a business
combination for cash would be recorded at the amount of cash paid, and assets acquired in a business
combination involving the issuance of debt, preferred stock, or common stock would be recorded
at the current fair value of the assets or of the debt or stock, whichever was more clearly
evident.
Under purchased method change in the basis of accounting occurs, thus acquired entity's assets
are to be recorded at their current fair values not at book value and goodwill is also created. This
approach is known as purchase accounting for business combination, and was widely used prior
to the increase in popularity of pooling-of-interests accounting. According to SFAS No. 141, the
following principles should be used for applying Acquisition (Purchase) Method of Accounting
for business combinations:
Recognition Principle - in a business combination accounted for under purchase accounting, the
acquirer recognizes all of the assets acquired and all of the liabilities assumed.
Fair Value Measurement Principle - in a business combination, the acquirer measures each
recognized asset acquired and each liability assumed and any non-controlling interests at its
acquisition date fair value.
Disclosure Principle - the acquirer should include the information in its financial statement so as
to help users of financial statements evaluate the nature and financial effect of business
combinations recognized by the acquirer. The disclosure should include primary reasons for
the business combination; the allocation of purchase price paid to the assets acquired and
liabilities assumed by major balance sheet caption; and when significant, disclosure of other
information such as amount of goodwill by reportable segment and the amount of purchase
price assigned to each major intangible asset class
Procedures under Purchase Method of Accounting for Business Combinations
1. Determination of the Combinor or the Acquiring Company - this steps deals with
identification of the combinor
2. Determination of the Acquisition Cost - assets to be acquired and liabilities to be assumed
are identified and then, like other exchange transactions, measured on the basis of the fair
values exchanged. The Cost of combinee includes also some other costs as discussed below.

3. Allocation of the Acquisition Cost - when assets are acquired in groups, it requires not only
ascertaining the cost of the asset (or net asset) group but also allocating that cost to the
individual assets (or individual assets and liabilities) that make up the group.

4. Determination of Goodwill -The goodwill should be determined and recorded under

purchased method
 5. Recording the Acquisition- the transaction is recorded as of the date of business
combination

6. Consolidation of Financial Statement and Accounting after business combinations - the

nature of an asset and the manner of its acquisitions determines an acquiring entity's
subsequent accounting for the asset (This will be discussed in chapter five)

1. Determination of the Combinor

To use the purchase method, one company must be designated as the "acquiring company or
combinor". Because the carrying amounts of the net assets of the combinor are not affected by a
business combination, the combinor must be accurately identified. Thus, FASB provided the
following guidelines in SFAS No. 141 for identifying the combinor (acquiring company):
 The FASB stated that in a business combination effected solely by the distribution
of cash or other assets or by incurring liabilities, the constituent company that distributes
cash or other assets or incurs liabilities is generally the acquiring entity [SFAS 141,
Par. 17].
 For combinations effected by the issuance of equity securities, the common theme
is that the combinor is the constituent company whose stockholders as a group retains or
receives the largest portion of the voting rights of the combined enterprise and thereby
can elect a majority of the governing board of directors or other group of the combined
enterprise. The company that issues the equity interest is generally the acquiring
company. [SFAS141, Par. 18]

2. Determination of the Acquisition Cost

The acquisition cost in a business combination accounted for by the purchase method is the total
of:
 The amount of purchase consideration paid by the combinor.
 The combinor's direct out-of-pocket costs of the combination.
 Any contingent consideration that is determinable on the date of the business
combination
A. Amount of Consideration - this is the total amount of cash paid, the current fair value of
other assets distributed, the present value of debt securities issued, and the current fair (or
market) value of equity securities issued by the combinor.
B. Out-of-Pocket Costs - included in this category are legal fees and finder's fees. A
finder's fee is paid to the investment banking firm or other organizations or individuals
that investigated the combine, assisted in determining the price of the business
combination, and otherwise rendered services to bring about the combination. Costs of
registering and issuing debt securities in a business combination are debited to Bond
Issue Costs; they are not part of the cost of the combinee.
Costs of registering and issuing equity securities are not direct costs of the business
combination, but are offset against the proceeds from the issuance of the securities. Indirect
out-of-pocket costs of the combination, such as salaries of officers involved in the
combination, are expensed as incurred by the constituent companies.

Out-of-Pocket Costs of Business Combinations

 Direct out-of-Pocket Costs Indirect out-of-Pocket Costs
Finders fees Salary and overhead costs incurred in negotiation
Travel costs Allocation of general expenses
Accounting fees Fees associated with registering securities with SEC
Legal fees Cost of issuing equity securities
Investment banker advisory fees Cost of debt securities
Direct out-of-Pocket Costs are added to the Cost of Acquisition of Combinee where as indirect
out-of-pocket costs are immediately expensed by the constituent companies.
C. Contingent Consideration
Contingent consideration is additional cash, other assets, or securities that may be issuable in the
future, contingent on future events such as a specified level of earnings or a designated market
price for a security issued to complete the business combination.
Contingent consideration that is determinable on the consummation date of a combination
is recorded as part of the cost of the combination.
Contingent consideration not determinable on the date of the combination is recorded
when the contingency is resolved and the additional consideration is paid or issued (or
becomes payable or issuable).

3. Allocation of the Acquisition Cost

According to SFAS No. 141, the following principles for allocating cost of a combine in a
purchase-type business combination are applicable:
The cost of a combinee in a business combination must be allocated to assets (other than
goodwill) acquired and liabilities assumed based on their estimated fair values on the date
of the combination.
Any excess of total costs of the acquired company over the amounts allocated to identifiable
assets acquired less liabilities assumed is assigned to goodwill

Identifiable Assets and liabilities

As per SFAS No.141, methods for determining fair values of identifiable assets and liabilities of a
purchased combinee included:
 Present values for receivables and liabilities;
 Net realizable values for marketable securities, finished goods and goods-in-process
inventories, and for plant assets held for sale or for temporary use;
 Appraised values for intangible assets, land, natural resources, and non-marketable
securities; and
 Replacement cost for inventories of material and plant assets held for long-term use.

In addition, the Financial Accounting Standards Board has provided the following guidelines:
1. The following combinee intangible assets were to be recognized individually and valued
at fair value:
 Assets arising from contractual or legal rights, such as patents, copyrights, and franchises.
 Other assets that are separable from the combinee entity and can be sold, licensed,
exchanged, and the like, such as customer lists and non-patented technology.
2. A part of the cost of a combinee is allocable to identifiable tangible and intangible assets
that resulted from research and development activities of the combined enterprise.
 Subsequently, such assts are to be expensed, as required by FASB Statement No. 2,
unless they may be used for other than research and development activities in the future.
3. In a business combination, leases of the combinee-lessee are classified by the combined
enterprise as they were by the combinee unless the provisions of the lease are modified
to the extent it must be considered a new lease. Thus, unmodified capital leases of the
combinee are treated as capital leases by the combined enterprise, and the leased
property and related liability are recognized in accordance with the guidelines of FASB
statement No. 141.
4. A combinee in a business combination may have pre-acquisition contingencies, which
are contingent assets (other than potential income tax benefits of a loss carry forward),
contingent liabilities, or contingent impairments of assets, that existed prior to
completion of the business combination. If so, an allocation period, generally not longer
than one year from the date the combination is completed, may be used to determine
the current fair value of a pre-acquisition contingency. A portion of the cost of a purchased
combinee is allocated to a pre-acquisition contingency whose fair value is determined during the
allocation period. Otherwise, an estimated amount is assigned to a pre-acquisition contingency if
it appears probable that an asset existed, a liability had been incurred, or an asset had been
impaired at the completion of the combination. Any adjustment of the carrying amount of a pre-
acquisition contingency subsequent to the end of the allocation period is included in the
measurement of net income for the accounting period of the adjustment.

4. Determination of Goodwill
Goodwill: Goodwill frequently is recorded in purchase-type business combinations because the total cost
of the combinee exceeds the current fair value of identifiable net assets of the combinee. That is, goodwill
is the difference between the total acquisition costs less current fair value of the net assets (the current fair
value of the assets less current fair value of liabilities). The amount of goodwill recorded on the date the
business combination may be adjusted subsequently when contingent consideration becomes issuable.
The goodwill can be determined into two ways: Goodwill as payment for super profit (extra profit or
excess income) and Goodwill as excess cost of acquisition over the current fair value of net
assets
1. Goodwill as payment for super profit (extra profit or excess income)
The purchaser (Combinor) may attempt to forecast the future income of the target company
(combinee) in order to arrive at a logical purchase price. Goodwill is a payment for above normal
expected future earnings. Earnings above the normal return are taken as the base for calculating
the value of Goodwill.
Example 2.2: You are given the following data:
Total Current Fair Value of Gross Assets.......................................................Br 85,000
Industry Normal rate of return is................................................................... 10%
Expected average future earning.................................................................... 10,500
Required:
A. Calculate the goodwill at four years' excess income
B. Calculate goodwill if the combinor expects the excess income for ever
C. Calculate goodwill when the combinor expects the excess income only for 10 years
D. Calculate goodwill if the current fair value of liabilities Br 10,000 and total acquisition cost
of Br 90,000
Determination of the Extra Profit:
Expected Profit ..................................................................................Br 10,500
Less: Normal Profit (= Br 85,000 @ 10%) ....................................... (8,500)
Extra profit......................................................................................... 2,000
Calculation of Goodwill
A. Calculate the goodwill at four years' excess income
Goodwill = Extra Profit @ 4
Goodwill = Br 2,000 @ 4= Br 8,000
B. Calculate goodwill if the combinor expects the excess income for ever
Goodwill = Extra profit / industry normal rate of return = Br 2,000 / 10% = Br 20,000
C. Calculate goodwill when the combinor expects the excess income only for 10 years
Goodwill = Extra profit @ PVIF of Ordinary Annuity (10% for 10 Years)
Goodwill = Br 2,000 @ 6.145 = Br 12,290
D. Calculate goodwill if the current fair value of liabilities Br 10,000 and total acquisition cost
of Br 90,000
Goodwill = Total Acquisition Cost - Current Fair Value of Net Assets
Current Fair Value of Net Assets = Total CFV of Assets - CFV of Liabilities
Current Fair Value of Net Assets = Br 85,000 - 10,000 = Br 75,000
Goodwill = Br 90,000 - 75,000 = Br 15,000
2. Goodwill as excess cost of acquisition over the current fair value of net assets
When goodwill is determine as excess cost of acquisition over the current fair value of net assets
one of the following circumstances may occur:
If total Acquisitions Cost = FMV of the net Assets, no goodwill is recognized
If Total Acquisitions Cost > FMV of the net Assets, it will result in a positive goodwill
If Total Acquisitions Cost < FMV of the net Assets, it will result in a Negative Goodwill
Negative Goodwill
In some purchase-type business combinations (known as bargain purchases), the current fair
values assigned to the identifiable net assets acquired exceed the total cost of the combinee
(acquisition cost).
A bargain purchase is most likely to occur for a combinee with a history of losses or when
common stock prices are extremely low.
The excess of the current fair values over total cost is applied pro rata to reduce (but not below
zero) the amounts initially assigned to non-current assets other than investments accounted
for by the equity method; assets to be disposed of by sale; deferred tax assets; prepaid assets
relating to pension or other postretirement benefits; and any other current assets.
If the foregoing proration does not extinguish the bargain-purchases excess, a deferred credit,
sometimes termed negative goodwill, is established. Negative goodwill means an excess of
current fair value of the combinee's identifiable net assets over their cost to the combinor.
Negative Goodwill is recognized as an extraordinary gain by the combinor. (SFAS No. 141)
 Example 4.3: Green Company is considering acquiring the assets of Gold Company by
assuming Gold's liabilities and by making cash payment. Gold Company has the following
balance sheet on the date of negotiations:
Gold Company
Balance Sheet
December 31, 1994
Assets: Liabilities and Equity:
Accounts Receivable..................................100,000 Total Liabilities.................................... 200,000

Inventory....................................................100,000 Capital Stock (Br10 Par)...................... 100,000

Land...........................................................100,000 Additional PIC..................................... 200,000

Building (Net)............................................220,000 Retained Earnings............................... 300,000

Equipment (Net)........................................280,000

Total Asset.................................................800,000 Total Liabilities and Equity.................. 800,000

Appraisal indicates that the inventory is undervalued by Br 25,000; building is undervalued by

Br 80,000; the equipment is overstated by Br 30,000; and the liability is overstated by Br 10,000.
Determine the Goodwill that is recognized if Green Company pays Br 900,000 cash for the net
assets of Gold Company.
Calculation of Net Assets:
Particulars Birr
Accounts Receivable......................................... 100,000

Inventory........................................................... 125,000

Land................................................................... 100,000

Building (Net)................................................... 300,000

Equipment (Net)................................................ 250,000

Gross Identifiable Assets................................... 875,000

Less: CFV of total Liabilities............................ (210,000)

Net Assets at CFV............................................. 665,000

Calculation of Goodwill:
Total Acquisition Cost..................................
Br 900,000

Less: Net Assets at CFV...............................(665,000)

Goodwill.......................................................
Br 235,000

5. Recording the Acquisition

Under purchase accounting, both the combinor and combinee record transactions relating to the
business combination. The combinee that is dissolved and liquidated passed the following
journal entries:
Books of Combinee Company (Acquired Company)
General journal entry passed For Liquidation of the Combinee
Liabilities (Individually).....................................................
xxxxx

Common Stock....................................................................
xxxxx

Additional PIC - CS............................................................

xxxxx

Retained Earnings...............................................................
xxxxx

All Assets (Individually)......................................... xxxxx

Books of Combinor Company (Acquiring Company)

General Journal Entry to be passed in the Books of the Combinor
1. Recording the payment (the purchase consideration or purchase price)
Investment in Combinee Company...........................................xxxxx

Cash............................................................................ xxxxx

Common Stock........................................................... xxxxx

Additional PIC - CS................................................... xxxxx

Bonds......................................................................... xxxxx

2. Recording direct out-of-pocket costs (legal and finder's fee)

Investment in Combinee Company...........................................
xxxxx

Cash......................................................................... Xxxxx
3. Recording the Indirect Out-of-Pocket Costs
Indirect out of pocket costs first are debited to the indirect expenses account for all the Indirect
out of pocket costs and then closed to the Additional PIC account. The other alternative is to
directly debit Additional PIC for the amount of indirect out of pocket costs as just below.
Addition PIC - CS.....................................................................
xxxxx

Cash......................................................................... xxxxx

4. Recording Assets and Liabilities (the Investment Account is replaced with assets and
liabilities)
All Assets, Individually, at CFV............................................... xxxxx

Goodwill................................................................................... xxxxx

Liabilities (Individually) at CFV............................... xxxxx

Investment in Combinee Company xxxxx

....................................................................................

Illustration on Purchase Method of Accounting for Statutory Merger with Positive

Goodwill
Example 4.4: Combinor Company acquired Combinee Company On December 31, 2002 with
the following balance sheet items:
Combinee Company
Balance Sheet
December 31, 2002
Assets: Liabilities and Equity:
Cash....................................................... 60,000Current Liabilities............................ 180,000

Other Current Assets............................. 420,000Long-term debt................................. 250,000

Land...................................................... 400,000Capital Stock (Br 10 Par)................. 200,000

Building (net)........................................ 240,000 PIC in Excess of Par........................ 320,000

Equipment (net).................................... 280,000Retained Earnings............................ 450,000

Total Asset............................................. 1,400,000 Total Liabilities and Equity......... 1,400,000

After in depth study, Combinor Company's BOD established the following Current Fair Value for assets
and liabilities:
Other Current Assets........................................................500,000

Land.................................................................................450,000

Building (Net)..................................................................300,000

Equipment (Net)...............................................................250,000

Long-term debt.................................................................240,000

Accordingly on December 31, 2002 Combinor issued 100,000 shares of its Br 10 Par (Current
Fair Value of Br 13) Common Stock for all the net asset of Combinee on a purchase type of
business combination. Also on December 31, 2002 Combinor paid the following out-of-pocket
costs in connection with the combination:
Finder's Fees and Legal Fees................................................. 180,000
Costs associated with issuance of shares............................... 120,000
Required: Prepared General Journal Entries for Combinor Company on December 31, 2002
Calculation of Total Acquisition Cost:
Common Stock (Br 13 @ 100,000 Shares)....................................1,300,000

Finder's Fees and Legal Fees 180,000

.........................................................................................................
Total Acquisition Cost..................................................................... 1,480,000

Calculation of Net Assets at CFV:

Cash.................................................................................................
60,000

Other Current Assets.......................................................................

500,000

Land................................................................................................
450,000

Building (net)..................................................................................
300,000

Equipment (net)..............................................................................
250,000

Total Assets at CFV........................................................................

1,560,000

Less: Liabilities at CFV (180,000 + 240,000)................................

(420,000)

Net Assets at CFV...........................................................................

1,140,000

Calculation of Goodwill:
Total Purchase Cost.........................................................................
1,480,000

Less: Net Assets at CFV.................................................................

(1,140,000)

Goodwill.........................................................................................
(340,000)

Journal Entries:
1. Recording the payment (the purchase consideration)
Investment in Combinee Company.................................................
1,300,000

Common Stock........................................................... 1,000,000

PIC in excess of Par................................................... 300,000

2. Recording Direct out-of-pocket costs (legal and finder's fee)

Investment in Combinee Company.................................................
180,000

Cash............................................................................... 180,000

3. Recording indirect out-of-pocket costs

Additional PIC - CS 120,000
........................................................................................................
Cash............................................................................... 120,000

4. Recording Assets and liabilities (Allocation)

Cash..................................................................................... 60,000

Other Current Assets............................................................ 500,000

Land..................................................................................... 450,000

Building (net)....................................................................... 300,000

Equipment (net)................................................................... 250,000

Goodwill.............................................................................. 350,000

Current Liabilities............................................ 180,000

Long-term debt................................................ 240,000

Investment in Combinee Company.................. 1,480,000

Example 4.5: On December 31, Year 1, META Company (the combinee) was merged into
SAXON Corporation (the combinor or surviving company). Both companies used the same
accounting principles for assets, liabilities, revenue, and expenses and both had a December 31
fiscal year. SAXON exchanged 150,000 shares of its Br 10 par common stock (Current Fair
Value Br 25 a share) for all 100,000 issued and outstanding shares of META's no-par, Br 10
stated value common stock. In addition, Saxon paid the following out-of-pocket costs associated
with the business combination:
Accounting fees:
For investigation of META Company as prospective combinee..........................Br 5,000
For SEC registration statement for Saxon common stock...................................... 60,000
Legal Fees:
For the business combination.................................................................................. 10,000
For SEC registration statement for Saxon common stock...................................... 50,000
Finder's fee........................................................................................................................ 51,250
Printing charges for securities and SEC registration statement.......................................... 23,000
SEC registration statement fee............................................................................................ 750
Total out -of- pocket costs of business combination........................................................... 200,000

There was no contingent consideration in the merger contract. Immediately prior to the merger,
META Company's condensed balance sheet was as follows:
META COMPANY (Combinee)
Balance sheet (Prior to Business Combination)
December 31, Year 1
Assets:
Current assets............................................................ Br1,000,000

Plant assets (net).......................................................... 3,000,000

Other assets.................................................................. 600,000

Total assets................................................................... 4,600,000

Liabilities & Stockholder Equity:

Current liabilities............................................................ 500,000

Long-term debt...............................................................1,000,000

Common stock, no par Br 10 stated value......................1,000,000

Paid in capital.................................................................. 700,000

Retained Earnings...........................................................1,400,000

Total................................................................................4,600,000
Using the guidelines in SFAS No. 141, "Business Combinations," the board of directors of Saxon
Corporation determined the current fair values of META Company's identifiable assets and
liabilities (identifiable net assets) as follows:
Current asset...................................................................
Br1,150,000

Plant assets...................................................................... 3,400,000

Other assets..................................................................... 600,000

Current liabilities (500,000)

........................................................................................
Long-term debt (present value)....................................... (950,000)

Identifiable net assets of combinee................................. 3,700,000

The condensed journal entries that follow are required for SAXON Corporation (the Combinor)
to record the Merger with META Company on December 31, Year 1, as a Purchase-type
business combination. SAXON uses an investment ledger account to accumulate the total cost of
META Company prior to assigning the cost to identifiable net assets and goodwill

SAXON Corporation (Combinor)

Journal Entries
December 31, Year 1
To record merger with META Company as a purchase.
Investment in META Company Common Stock (150,000 X Br 25).............3,750,000
Common Stock (150,000 X Br 10)............................................ 1,500,000
Paid-in Capital in Excess of par................................................ 2,250,000

To record payment of direct costs incurred in merger with META Company. Legal and finder's
fees in connection with the merger are recorded as an investment cost: other out-of-pocket costs
are recorded as a reduction in the proceeds received from issuance of common stock.
Investment in META Company Common Stock
(Br5,000+Br10,000+ Br 51,250)................................................................... 66,250
Paid-in Capital in Excess...............................................................................133,750
Cash...................................................................... 200,000
To allocate cost of META Company investment to identifiable assets and liabilities, with the
remainder to goodwill. Amount of goodwill is computed as follows:
Current Assets................................................................................................1,150,000
Plant Assets ...................................................................................................3,400,000
Other Assets................................................................................................... 600,000
Discount on Long-Term Debt........................................................................ 50,000
Goodwill........................................................................................................ 116,250
Current Liabilities........................................................................ 500,000
Long-Term Debt .......................................................................... 1,000,000
Investment in META Company Stock......................................... 3,816,250
Determination of Goodwill:
Total cost of investment (Br 3,750,000 + Br 66,250)................................ Br 3,816,250
Less: Net Assets (NAs) at CFV
Carrying amount of META's identifiable NAs (4,600,000-1,500,000)......3,100,000
Excess (Deficiency) of current fair values assets and liabilities
Current assets.............................................. 150,000
Plant assets................................................. 400,000
Long-term debt........................................... 50,000
Total Net Assets at CFV............................................................................. (3,700,000)
Amount of goodwill................................................................................... Br 116,250

NOTE: No adjustments are made in the foregoing journal entries to reflect the current fair
values of Saxon's identifiable net assets or goodwill, because SAXON is the Combinor in the
business combination. META Company (the combinee) prepares the condensed journal entry
below to record the dissolution and liquidation of the company on December 31, Year 1:

META COMPANY (Combinee)

Journal Entry
December 31, Year 1

Current Liabilities..................................................... 500,000

Long-Term Debt....................................................... 1,000,000

Common Stock, Br 10 stated value.......................... 1,000,000

Paid-in Capital in Excess of Stated value................. 700,000

Retained Earnings..................................................... 1,400,000

Current Assets............................................... 1,000,000

Plant Assets (net) 3,000,000
.......................................................................

Other Assets.................................................. 600,000

To record liquidation of company in conjunction with merger with
Saxon Corporation

Exercise 4.1: Grant Company has been looking to expand its operations and has decided to
acquire the assets of TURNER Company and MURPHY Company. GRANT Company will
issue 25,000 shares of its Br 10 par common stock to acquire the net assets of Turner Company
and will issue 12,000 shares to acquire the net asset of Murphy Company. The Balance Sheet of
the acquired companies (combinees) is as follows:
Turner Murphy
Company Company
Assets: In Birr In Birr
Accounts Receivables................................................. 200,000 80,000

Inventory..................................................................... 150,000 85,000

Land............................................................................ 150,000 50,000

Building...................................................................... 500,000 300,000

Accumulated Depreciation......................................... (150,000) (110,000)

Total Assets................................................................. 850,000 405,000

Liabilities and SH Equity:

Current liabilities........................................................ 160,000 55,000

Bonds payable............................................................. 100,000 100,000

Common Stock (Br 10 par)........................................ 300,000 100,000

Retained earnings........................................................ 290,000 150,000

Total liabilities and equity........................................... 850,000 405,000

The following current fair values (CFV) are agreed upon by the BODs of the combinees
companies and Grant Company while the others have the same book values and current fair
values:
 Turner Murphy
Company Company
Inventory..................................................................... 200,000 100,000

Land............................................................................ 200,000 60,000

Building (net).............................................................. 400,000 350,000

Bonds payable............................................................. 80,000 95,000

Grant's stock is currently traded at Br 40 per share. Grant will incur Br 5,000 direct acquisition
cost in Turner Company and Br 4,000 of direct acquisition cost in Murphy Company. Grant also
incurred Br 13,000 other indirect cost of acquisition and Br 15,000 registration and issue cost.
Required: Record the acquisition cost on the books of Grant Company using Purchase
Accounting principles (Purchase Method)
Checking Figures: Turner Company Murphy Company
Total Acquisition Cost.................................... Br 1,005,000 Br 484,000

Net assets....................................................... 760,000 440,000

Goodwill........................................................ 245,000 44,000

Example 4.6: Purchase Accounting for Acquisition of Assets, with "Negative Goodwill"
On December 31, Year 1, Davis Corporation acquired the net assets of Fairmont Corporation
for Br 400,000 cash, in a purchase-type business combination. Davis paid legal fees of Br 40,000
in connection with the combination. The condensed balance sheet of Fairmont prior to the
business combination, with related current fair value data, is presented below:
FAIRMONT CORPORATION (Combinee)
Balance Sheet (Prior to Combination)
December 31, Year 1
Carrying Market
Amounts Values
Assets:

Current assets......................................................................... Br190,000 Br 200,000

Investment in marketable securities....................................... 50,000 60,000

Plant assets (net).................................................................... 870,000 900,000

Intangible assets (net)............................................................ 90,000 100,000

Total assets............................................................................. 1,200,000 1,260,000

Liabilities &Stockholders' Equity:
 Current Liabilities.................................................................. 240,000 240,000
Long-term debt.......................................................................
500,000 520,000
Total Liabilities......................................................................
740,000 760,000

Common stock, Br 1 par ....................................................... 600,000

Deficit (Dr. balance in Retained earnings)............................. (140,000)

Total stockholders' equity......................................................
460,000
Total liabilities & stockholders' equity....................... 1,200,000

Thus, Davis Corporation acquired identifiable net assets with a current fair value of Br 500,000
(Br 1,260,000 - Br 760,000 = Br 500,000) for a total cost of Br 440,000 (i.e. Br 400,000 + Br
40,000). The Br 60,000 excess of current fair value of the net assets over their cost to Davis
Corporation (500,000 - 440,000 = 60,000) is prorated to the plant assets and intangible assets in
the ratio of their respective current fair values as follows:
 Prorated to plant assets: (900,000 / 1,000,000) @ 60,000 = 54,000
 Prorated to intangible assets: (100,000 /100,000) @ 60,000 = 6,000
No part of the Br 60,000 bargain-purchase excess is allocated to current assets and to the
investment in marketable securities. The journal entries for by Davis Corporation for acquisition
of the net assets of Fairmont Corporation and payment of Br 40,000 legal fees are shown below:
To record acquisition of net assets of Fairmont corporation
Investment in net assets of Fairmont Corporation..............................
400,000

Cash .................................................................................... 400,000

To record payment of legal fees incurred in acquisition of net assets

Investment in net assets of Fairmont Corporation..............................
40,000

Cash........................................................................................ 40,000

To allocate total cost of net assets acquired to identifiable net assets, with excess of current
fair value of the net assets over their cot prorated to noncurrent assets other than investments
in marketable debt securities.(income tax effects are disregarded)
Current assets....................................................................................................... 200,000

Investment in marketable debt securities............................................................. 60,000

Plant assets (900,000- 54,000)............................................................................. 846,000

Intangible assets (100,000 -6,000)....................................................................... 94,000

Current liabilities 240,000

 ..................................................................................................................
Lon-term Debt 500,000
..................................................................................................................
Premium on long-term debts (520,000- 500,000) 20,000
..................................................................................................................
Investment in net assets of Fairmont Corporation (400,000+ 40,000) 400,000
..................................................................................................................

Exercise 4.2: Thompson Company is purchasing the net assets of Green Company on
December 31, 2003, when Green Company has the following B/Sheet
Green Company (Combinee)
Balance Sheet
December 31, 2003
Assets: Liabilities and Equity:
Other Current Assets............................. 100,000Current Liabilities ....................................... 90,000

Land...................................................... 50,000Common Stock (Br 10 Par).. 200,000

Building (Net)....................................... 200,000 Retained Earnings................ 140,000

Equipment (Net).................................... 60,000 Total stockholders' Equity .......................... 340,000

Goodwill............................................... 20,000

Total Asset............................................. 430,000 Total Liabilities and Equity......................... 430,000

Thompson Company has obtained the following Current Fair Values for Green Company
accounts:
Assets: Birr
Other Current Assets...................................................... 120,000

Land .............................................................................. 100,000

Building (Net)................................................................ 250,000

Equipment (Net)............................................................ 150,000

Current Liabilities.......................................................... 92,000

Direct acquisition costs are Br 18,000 and indirect acquisition costs are Br 5,000. Determine the
Negative Goodwill and show the proration to noncurrent assets and prepare journal entries to
record the purchase of Green Company assuming the cash payment by Thompson Company is
Br 450,000. Thompson Company will assume the liabilities.
Checking Figures:
Total Acquisition Cost...................................................... Br 468,000

Net Assets......................................................................... 528,000

Negative Goodwill........................................................... Br 60,000

Exercise 4.3: the Combinor Company acquires the Combinee at a total acquisition cost of Br
1,800,000 where the Current Fair Value of Net Assets is Br 2,000,000. The only Noncurrent
Assets that can be used to prorate negative Goodwill is a Building (net) with CFV of Br 130,000.
Determine the Negative Goodwill that is recorded in the books of Combinor Company

6. Financial Statement and Accounting after business combinations

Under both purchase accounting, the balance sheet for the combined enterprise issued as of the
date of the business combination accomplished through statutory merger, statutory consolidation,
or acquisition of assets includes all the assets and liabilities of the constituent companies. The
consolidated balance sheet issued immediately following a combination that results in a parent-
subsidiary relationship will be described in the next chapter. In a balance sheet following a
purchase type business combination, assets and liabilities of the combinor are at carrying
amounts, assets acquired from the combinee are at current fair values (adjusted for any
bargaining purchase excess), and retained earnings is that of the combinor only. The income
statement of the combined enterprise for the accounting period in which a purchase type business
combination occurred includes the operating results of the combinee after the date of the
combination only.

Disclosure of Business Combinations in a Note to the Financial Statements

Because of the complex nature of business combinations and their effects on the financial
position and operating results of the combined enterprise, extensive disclosure is required for the
periods in which they occur.

Disclosures under the Purchase Method

The Accounting Principles Board required disclosure of the following aspects of a purchase -
type business combination in a note to the financial statements for the period in which the
business combination took place: name and brief description of the combinee; period for which
combinee's operating results are included in the income statement of the combined enterprise;
cost of the combinee, including number of shares and value per share of common stock issued,
and nature of and accounting treatment for contingent consideration; amortization policy for
goodwill recorded in the combination; and pro forma operating results for the combined
enterprise for the current and preceding accounting periods as though the combination had
occurred at the beginning of the preceding period.
Subsequently, the Financial Accounting Standards Board waived the pro forma disclosures for
nonpublic enterprises whose debt and equity securities are not publicly traded.
The following note to the financial statement of a publicly owned company illustrates the
required disclosures for a purchase-type business combination:

Purchase On April 1, Year 2, the company acquired substantially all the assets, including
inventories, of Combine Company of Br 8,400,000 cash and an agreement to make future
payments through July, Year 5, contingent on sales of one of the acquired brands. The acquisition
has been accounted for as a purchase, and the excess (Br 399,000) of the consideration paid on
acquisition over the current fair value of the identifiable tangible and intangible net assets
acquired is being amortized over 15 years. Contingent payments are also being recorded as
intangible assets and amortized over the then remaining economic life. The results of operations
of Combinee are included in the consolidated income statement since the date of acquisition.
Had the acquisition taken place on January 1, Year 1, unaudited pro forma sales for the years
ended December 31, Year 2 and Year 1 would be Br 793,627,000 and Br 777,715,000,
respectively, and unaudited pro forma data reflect adjustment for amortization of intangible
assets and imputed interest.

Purchase Accounting for Statutory Consolidation

Because a new corporation issues common stock to effect a statutory consolidation, one of the
constituent companies must be identified as the combinor, under the criteria described to identify
combinor. Once the combinor has been identified, the new corporation recognizes net assets
acquired from the combinor at their carrying amount in the combinor's accounting records;
however, net assets acquired from the combinee are recorded by the new corporation at their
current fair values. To illustrate, assume the following condensed balance sheets of the
constituent companies involved in a purchase-type statutory consolidation on December 31, Year
1999:
Lamson Corporation & Donald Company
Balance Sheet (Prior to Combination)
December 31, 1999
Asset LAMSON DONALD
Company Company
Current assets.......................................................... Br 600,000 400,000

Plant asset (net)....................................................... 1,800,000 1,200,000

Other assets............................................................. 400,000 300,000

Total assets.............................................................. 2,800,000 1,900,000

Liabilities & Shareholders Equity

Current liabilities.................................................... 400,000 300,000

Long-term debt....................................................... 500,000 200,000

Common stock, Br10.............................................. 430,000 620,000

Paid in capital......................................................... 300,000 400,000

Retained Earning.................................................... 1,170,000 380,000

Total........................................................................ 2,800,000 1,900,000

The current fair values of both companies' liabilities were equal to carrying amounts. Current fair
values of identifiable assets were as follows for Lamson and Donald, respectively: current
assets, Br 800,000 and Br 500,000; plant assets, Br 2,000,000 and Br 1,400,000; other assets, Br
500,000 and Br 400,000.

On December 31, Year 1999, in a statutory consolidation approved by shareholders of both

constituent companies, a new corporation, LamDon Corporation, issued 74,000 shares of no
stated value common stock with an agreed value of Br 60 a share, based on the following
valuations assigned to the two constituent companies' identifiable net assets and goodwill.

LAMSON DONALD
Corporation Company
Current Fair Value of Identifiable Net Assets:
Lamson: Br 800,000 + 2,000,000+500,000-400,000-500,000...... 2,400,000

Donald: Br 500,000 +1,400,000+400,000-300,000 -200,000........ 1,800,000

Goodwill assigned to determine number of shares issued............. 180,000 60,000

Net assets' current fair value......................................................... 2,580,000 1,860,000

Number of shares of LamDon to be issued to constituent

companies' Stockholders, at Br 60 a share agreed value............... 43,000 31,000

58% 42%

Because the former shareholders of Lamson Corporation receive the largest interest in the
common stock of LamDon Corporation (43/74 or 58%), Lamson is the combinor in the
purchase-type business combination. Assuming that LAMDON paid a Br 200,000 out-of-pocket
cost which comprises Br 110,000 direct and Br 90,000 indirect for the statutory consolidation
after it was consummated on December 31, Year 1999; LAMDON's journal entries would be as
follows:

To record consolidation of Lamson corporation and Donald company as a purchase

Investment in Lamson and Donald Company (74,000 @ 60).............................4,440,000
Common Stock, no-par ...........................................................................
4,440,000
To record payment of costs incurred in consolidation of Lamson Corporation and Donald
Company. Accounting legal and finder's fee in connection with the consolidation are recorded
as investment cost; pother out-of-pocket costs are recorded as a reduction in the proceeds
received from the issuance of common stock.
Investment in Lamson and Donald Company common stock......................110,000
Common stock, no par.................................................................................. 90,000
Cash ..................................................................................... 200,000

To allocate total cost of investment to identifiable assets and liabilities, at carrying mount for
combinor Lamson corporation's net assets and at current fair value for combinee Donald
company's net assets.(income tax effects are disregarded).
Assume Lamson Corporation was identified as Combinor and valued Current Assets at Br
500,000; Plant assets at Br 1,400,000; and Other assets at Br 400,000 of Donald Company:
Current assets (600,000 + 500,000)..................................................................... 1,100,000
Plant assets (1,800,000 + 1,400,000)................................................................... 3,200,000
Other assets (400,000 +400,000)......................................................................... 800,000
Goodwill.............................................................................................................. 850,000
Current liabilities (400,000 +300,000)...........................................................
700,000
Long-term Debt (500,000+ 200,000) ............................................................
700,000
Investment in Lamson and Donald Co common stock (4,440,000+110,000)
4,550,000

Note in the foregoing journal entry that because of the combinor's net assets' being recorded at
carrying amount and because of the Br110,000 direct costs of the business combination, the
amount of goodwill is Br850,000, rather than Br240,000 (Br180,000+Br60,000=Br240,000), the
amount assigned by the negotiating directors to goodwill in the determination of the number of
shares of common stock to be issued in the combination.
Amount of Goodwill is computed as follows:
Total cost of investment (4,440,000 + 110,000) ........................................Br4,550,000
Less: Carrying amount of Lamson's Identifiable net Assets....................... (1,900,000)
Current Fair Value of Donald's Identifiable net assets ............................... (1,800,000)
Amount of Goodwill................................................................................... Br850,000

Appraisal of Accounting Standards for Business Combinations

The accounting standards for business combinations described and illustrated in the preceding
pages of may be criticized on grounds that they are not consistent with the conceptual
framework for financial accounting and reporting.

Criticism of Purchase Accounting:

The principal criticisms of purchase accounting center on the recognition of goodwill. Many
accountants take exception to the residual basis for valuing goodwill established in APB
Opinion No. 16. These critics contend that part of the amount thus assigned to goodwill probably
apply to other identifiable intangible assets. Accordingly, goodwill in a business combination
should be valued directly by use of methods as described in your Intermediate Accounting
course. Any remaining cost not directly allocated to all identifiable tangible and intangible assets
and to goodwill would be apportioned to those assets based on the amounts assigned in the first
valuation process or recognized as loss. The accounting described for the excess of current fair
values over total cost in a bargain-purchase business combination also has been challenged.
Critics maintain there is no theoretical support for the arbitrary reduction of previously
determined current fair values of assets by an apportioned amount of the bargain-purchase
excess. They suggest the amortization treatment described on page 6 for the entire bargain-
purchase excess. Other accountants question whether current fair values of the combinor's net
assets-especially goodwill-should be disregarded in accounting for a current fair values for net
assets of the combine only, in view of the significance of many combinations involving large
constituent companies.

Exercise 4.4: On January 31, 2004, EDGET Corporation acquired for Br five hundred forty
thousands (540,000) cash all the net assets except cash of HIBRET Company and paid Br
60,000 to a law firm for legal services in connection with the business combination. The balance
sheet of HIBRET Company on January 31, 2004 was as follows:
HIBRET Company
Balance Sheet
January 31, 2004
Assets: Liabilities and Shareholders' Equity
Cash ........................................... 40,000Liabilities.................................. 620,000

Other Current Assets.................. 280,000Common Stock.........................................

250,000

Plant Assets (net)........................ 760,000Retained Earning......................................

330,000

Intangible Assets ....................... 120,000

Total Assets ............................... 1,200,000Total Liab. & SHEs..................................

1,200,000

The present value of HIBRET Company's liabilities on January 31, 2004 was Br 620,000, the
current fair values of its non-cash assets were as follows on January 31, 2004:
Other current assets.......................................................... 300,000

Plant Assets....................................................................... 874,000

Intangible Assets............................................................... 76,000

Instruction: Prepare journal entries for EDGET Corporation on January 31, 2004 to record the
acquisition of net assets of HIBRET Company's except cash
Checking Figures:
Total Acquisition Cost............................................................ 600,000
Net Assets............................................................................... 630,000

Goodwill (Negative)............................................................... 30,000

Adjusted Plant Assets (874,000 - 27,600)............................... 846,400

Adjusted Intangible Assets (76,000 - 2,400)........................... 73,600

Exercise 4.5:
The balance sheet and the current fair values of EXCEL Corporation on March 31, 2002 were as
follows:
EXCEL Corporation
Balance Sheet
March 31, 2002
Assets Liabilities and Shareholders' Equity
BV CFV BV CFV
Other Current Assets.................................
500,000 575,000Current liabilities......................................
300,000 300,000

Plant Assets (net) 1,000,00 1,200,00Liabilities 400,000 450,000

....................................... 0 0..................................................
Patent (net).............................100,000 50,000Common Stock (10 par)........................... 100,000

Retained Earning......................................
800,000

Total Assets...........................
1,600,000 Total Liab. & SHEs..................................
1,600,000

On April 1, 2002, VALUE Corporation issued 50,000 shares of its no-par, no stated value
common stock (CFV Br 14 a share) and Br 225,000 cash for the net assets of EXCEL
Corporation in a purchase type business combination. Of the Br 125,000 out-of-pocket costs paid
by VALUE Corporation on April 14, 2002, Br 50,000 were legal fees and finder's fees related to
the business combination and the remaining related to the issuance of common stock.

Required: prepare journal entries for VALUE Corporation on March 31, 2002 to record the
business combination with EXCEL Corporation
Checking Figures:
Total Acquisition Cost............................................................975,000
 Net Assets...............................................................................
1,075,000

Goodwill, Negative.................................................................100,000

Adjusted Plant Assets (1,200,000 - 96,000)............................

1,104,000

Adjusted Patent (50,000 - 4,000)............................................ 46,000

Exercise 2.6: MOON Corporation agreed to purchase net assets of SUN Corporation. Just
prior to the acquisition, SUN's Balance Sheet is as follows:
SUN Corporation
Balance Sheet
January 31, 2001
Assets: Liabilities and Shareholders' Equity:
Accounts Receivable................................
200,000Current Liabilities.....................................
80,000

Inventory...................................................
270,000Mortgage Payable.....................................
250,000

Equipment (net)........................................
100,000Common Stock (Br 10 par)......................
100,000

_______Retained Earnings.....................................
140,000

Total Assets ..............................................

570,000Total Liab. & SHEs..................................
570,000

The market values agree with Book Values except for the equipment which has an estimated
market value of Br 40,000. MOON Corporation paid Br 10,000 for direct acquisition costs and
Br 15,000 for indirect acquisition cost to consummate the transaction. Record the purchase on
the MOON Corporation assuming the cash paid to SUN Corporation is:
1. Br 180,000
2. Br 140,000
Also give the journal entry to liquidation of SUN Corporation
Checking Figures: Case 1 Case 2
Total Acquisition Cost................................................................
Br 190,000 Br 150,000

Net Assets................................................................................... 180,000 180,000

Goodwill.................................................................................... 10,000 (30,000)

Problem 2.1:
On December 31, 2006, Alpha Corporation issued 18,000 shares of its Br 2 par (current fair
value of Br 10 per share) common stock for all the outstanding common stock of Beta
Corporation in a statutory merger. Out-of-pocket costs of the business combination paid by
Alpha on December 31, 2006 are:
Direct costs of the business combination ............................... Br 22,000
Cost of registering and issuing common stock....................... 15,000
Total out-of-pocket costs of business combination ................ Br 37,000

Beta had the following balance sheet on December 31, 2006:

Beta Corporation
Balance Sheet
December 31, 2006
Book Market
Value Value
Assets: In Birr In Birr
Inventories.................................................................................. 96,000 110,000

Other current assets.................................................................... 52,000 52,000

Plant assets (net)........................................................................ 172,00 195,000

Total assets................................................................................. 320,000 357,000

Liabilities & Stockholders' Equity:

Liabilities................................................................................... 175,000 175,000

Common Stock, Br 5 par........................................................... 20,000

Additional paid-in capital.......................................................... 50,000

Retained earnings....................................................................... 75,000

Total liabilities & Stockholders' equity...................................... 320,000

Additional Information: a special copyright was not previously recorded on Beta's records.
The copyright has a current fair market value of Br 2,000. Beta had also Goodwill from previous
business combinations that amounts Br 5,000 on the date of business combination.
Required: Record the business combination under purchasing accounting. Show the
calculation that backs up the entries