Advanced Financial Accounting Module PDF

KB INTERNATIONAL BUSINESS AND TECHNOLOGY COLLEGE Center of Distance Education Module for ADVANCED ACCOUNTING I  Table of Contents Contents Pages Unit 1: Branch Accou...

KB INTERNATIONAL BUSINESS AND TECHNOLOGY COLLEGE Center of Distance Education Module for ADVANCED ACCOUNTING I  Table of Contents Contents Pages Unit 1: Branch Accounting 1 Unit 2: Introduction to Business Combination 20 Unit 3: The Purchase Method of Accounting and Consolidated Financial Statements at Date of Acquisition 31 Unit 4: The Purchase Method of Accounting: Subsequent to Date of Acquisition 48 Unit 5: The Purchase Method of Accounting: Partially Owned Subsidiaries 57 Unit 6: The Pooling of Interest Method of Accounting 73 Unit 7: Consolidated Financial Statements- Inter Company Transaction –– Inventory, Fixed Assets 83 UNIT ONE: BRANCH ACCOUNTING Contents 1.0 Aims and Objectives 1.1 Introduction 1.2 Overview of Branch Accounting 1.3 Objectives of Branch Accounts 1.4 Accounting Systems 1.4.1 Centralized Accounting 1.4.2 Decentralized Accounting 1.5 Branch General Ledger Accounting 1.5.1 Intra Company Accounts 1.5.2 Home Office Allocations 1.5.3 Inventory Transfer Accounts 1.5.4 Fixed Asset Accounts 1.5.5 Other General Ledger Accounts 1.6 Branch Accounting Illustrated 1.7 Combined Financial Statements: Inventory Transfer at Home Office Cost 1.7.1 Producing Financial Statements for the Branch 1.7.2 Producing Financial Statements for the Entire Company 1.8 Combined Financial Statements: Inventory Transfer Above Home Office Cost 1.9 Summary 1.10 Glossary 1.11 Answer for Check Your Progress Exercises 1.12 Model Exam Questions 1.0 AIMS AND OBJECTIVES When you have studied this unit you should be able to:  prepare the parallel journal entries to be recorded on the books of a home office and its branch office. 1   record the required entries on the books of a home office and its branch office when shipment are made to the branch under the following conditions: a) the shipments are made at the home offices cost. b) the shipments are made at a price that exceeds the home offices cost  adjust the unrealized profit in branch inventory account at the end of a firm’s accounting period.  prepare the combined financial statements for a home office and its branch office. 1.1 INTRODUCTION Accounting for the operation of a business can become complicated whenever geographical separation is encountered between the various facets of the organization. This unit examines the special procedures necessary to record transactions occurring at significant distances from a central office. Branch accounting is analyzed with illustrative examples. 1.2 OVERVIEW OF BRANCH ACCOUNTING The extensive use of branch operations is especially common in modern retailing where companies attempt to attract customers by offering the convenience of numerous outlets. Relative small companies often attempt to expand their market base by establishing additional outlets in nearby communities. This type of internal division is not even restricted to the retail function. Branch operations are commonly found in banking as well as in manufacturing and other industries. 1.3 OBJECTIVES OF BRANCH ACCOUNTS A business firm establishes branches for marketing the products or services. The parent firm (head office) is always interested to know the trading results of its branches. For this purpose, branch accounts are kept. The main purposes of branch accounts are as follows: (i) Branch accounts helps to know the profit or loss of each branch. (ii) It enables the head office to know the financial position of each branch. (iii) It shows the requirements of goods or cash for each branch. 2  (iv) Branch account is the basis and helps the head office to control the activities of branch. (v) Suggestions and improvements are based on the branch accounts. 1.4 ACCOUNTING SYSTEMS The home office must decide how to account for the activities and transactions of the branches. Accounting systems can be categorized as either centralized or decentralized. 1.4.1 Centralized Accounting Under a centralized accounting system, a branch does not maintain a separate general ledger in which to record the transaction. Instead, it sends source documents on sales, purchases, and payroll to the home office. Branches usually deposit cash receipts in local bank accounts, which the home office draws upon. When the home office receives source documents, it reconciles sales information with bank deposits, reviews and processes invoices for payment, and prepares payroll checks and related payroll related records. Centralized accounting systems are usually practical when the operations of the branches do not involve complex manufacturing operations or extensive retailing or service activities. 1.4.2 Decentralized Accounting Under a decentralized accounting system, a branch maintains a separate general ledger in which to record its transactions. Thus, the branch is a separate accounting entity, even though it is not a separate legal entity. It prepares its own journal entries and financial statements, submitting the latter to the head office, usually on a monthly basis. Decentralized accounting systems are common for branches that have complex manufacturing operations or extensive retailing operations involving significant credit sales. 3 1.5 BRANCH GENERAL LEDGER ACCOUNTING 1.5.1 Intra Company Accounts A branch is established when a home office transfers cash, inventory, or other assets to an outlying location. Because the home office views the assets transferred to the branch as an investment, it makes the following entry: Investment in branch --------------------------- xx Asset (s) ----------------------------------- xx On receipt of the assets from the home office, the branch makes the following entry: Asset(s) --------------------------------------- xx Home office equity ------------------------ xx The balance in the Investment in Branch account on the books of the home office always equals the balance in the Home Office Equity account on the books of the branch. In practice, these accounts are referred to as the Intra Company or reciprocal accounts. At the end of each accounting period, the branch closes its income or loss to its home office equity account. Upon the receipt of the branch’s financial statements, the home office adjusts its Investment in Branch account to reflect the branch’s income or loss and makes the offsetting credit or debit to an income statement account called branch income or branch loss. As a result of this entry and upon closing the branch income or branch loss account to retained earnings, the branch’s income or loss is included in the home office’s retained earnings account. 1.5.2 Home Office Allocations The home office usually arranges and pays for certain expenses that benefit the branches. The most common example is insurance. In theory, some portion of the insurance expense should be allocated to the various branches, so that the home office may determine the true operating income or loss of each branch. In practice, however, allocation of home office expenses varies widely. Numerous home offices allocate only those expenses that relate directly to the branch operations, such as insurance. Some home offices without any revenue producing operations of their own allocate all of their expenses to the branches. 4  Check Your Progress Exercise 1 1. What is a branch? … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … 2. What are the basic purposes of branch accounting? … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … 1.5.3 Inventory Transfer Accounts When inventory is transferred from the home office to a branch, all that has really happened is that the inventory has physically moved from one location in the company to another. A sale has not occurred, because sales takes place only between the company and outside customers. To measure the profitability of a branch, however, an intra company billing must be prepared. The branch uses special purchase account called Shipment From Home office to record these inventory transfers and makes the following entry: Shipments from home office ----------- xx Home office equity-------------xx The home office uses a special contra purchases account called Shipments to Branch to record inventory transfers. If the inventory is transferred and billed at the home office’s cost, the home office makes the following entry: Investment in branch ----------------------- xx Shipments to branch -------------------------xx The branch’s ending inventory, cost of goods sold, gross margin, and operating profit or loss depend on the amounts of these intra company billings. 1.5.4 Fixed Asset Accounts Some home offices require their branches-fixed assets to be recorded on the books of the home office instead of the books of the branches. Such a procedure automatically ensures 5 that uniform depreciation methods and asset lives are used for all branches. The home office usually charges the branch for the depreciation expense of its fixed assets. It does this by crediting accumulated depreciation and debiting the Investment in branch account instead of debiting depreciation expense. The branch debits depreciation expense and credits the Home office Equity account instead of crediting accumulated depreciation. When fixed assets are recorded on the home offices books, the fixed assets pertaining to the branch must be added to the Investment in Branch account to evaluate the profitability of branch operations in relation to the total assets actually invested in the branch. 1.5.5 Other general ledger Accounts The branch maintains the balance sheet and income statement accounts necessary to record transactions that take place between (1) the home office and the branch, and (2) the branch and its customers, creditors, and employees. 1.6 BRANCH ACCOUNTING ILLUSTRATED Assume that TANA Company, which prepares financial reports at the end of the calendar year, established a branch in Motta on July 1, 1998. The following transactions occurred during the formation of the branch and its first six months of operations, ending December 31, 1998. 1. The home office sent $ 28,000 cash to the branch to begin operations. 2. The home office shipped inventory to the branch. Intra company billings totaled $60,000, which is the home office cost. (Both the home office and the branch use a periodic inventory system.) 3. The branch acquired merchandise display equipment, which cost $ 12,000 on July 1, 1998. (Assume that branch fixed assets are not carried on the home office books.). 4. The branch purchased inventory costing $ 43,000 from outside vendors on account. 5. The branch had credit sales of $ 85,000 and cash sales of $ 35,000. 6. The branch collected $ 44,000 on accounts receivable. 7. The branch paid outside vendors $ 28,000. 6 8. The branch incurred selling expenses of $ 15,000 and general and administrative expenses of $ 12,000. These expenses were paid in cash when they were incurred and include the expense of leasing the branch’s facilities. 9. The home office charged the branch $ 2,000 for its share of insurance. 10. Depreciation expense on the merchandise display equipment acquired by the branch is $ 1,000 for the six month period. (Depreciation expense is classified as a selling expense.). 11. The branch remitted $ 10,000 cash to the home office. 12. The branch’s physical inventory on December 31, 1998, is $ 33,000, of which $ 25,000 was acquired from the home (there was no beginning inventory). The home office’s physical inventory on December 31, 1998, is $ 150,000 (the beginning inventory was $ 135,000). (Home office purchases were $ 285,000.). Cost of goods sold is determined and recorded in a separate account for each accounting entity. (Note that the year-end inventory accounts are adjusted in this entry to the year-end physical inventory balances). 13. The branch closes its income statement accounts. 14. The home office prepares its adjusting entry to reflect the increase in the branch’s net assets resulting from the branch’s operations. The following journal entries are recorded by TANA Company’s home office and its Motta branch for the transactions 1 through 14. 7 Exhibit 1-1 Home office books Branch books 1. Investment in branch $ 28,000 1. Cash $ 28,000 Cash 28,000 Home office equity 28,000 2. Investment in branch - - - 60,000 2. Shipments Shipments to branch 60,000 From home office 60,000 Home office equity 60,000 3. No entry 3. Equipment 12,000 Cash 12,000 4. No entry. 4. Purchases 43,000 Accounts payable 43,000 5. No entry. 5. Cash 35,000 Accounts receivable 85,000 Sales 120,000 6. No entry. 6. Cash 44,000 Account receivable 44,000 7. No entry. 7. Accounts payable 28,000 Cash 28,000 8. No entry. 8. selling expenses 15,000 Administrative expense 12,000 Cash 27,000 9. Investment in Branch 2,000 Administrative expenses 2,000 9. Administrative expenses 2,000 Home office equity 2,000 10. No entry. 10. Selling expenses 1,000 Accumulated depreciation 1,000 11. Cash 10,000 11. Home office Equity 10,000 Investment in Branch 10,000 Cash 10,000 12. Inventory 15,000 12. Inventory acquired From vendors 8,000 Shipments to Branch 60,000 Inventory acquired From home office 25,000 8  Cost of goods sold 210,000 Costs of goods sold 70,000 Purchases 285,000 Shipments from home office 60,000 Purchases 43,000 13. No entry. 13. Sales 120,000 Cost of goods sold 70,000 Selling expenses 16,000 Administrative expenses 14,000 Home office equity 20,000 14. Investment in Branch 20,000 14. No entry. Branch income 20,000 Check your progress Exercise 2 What are the two types of accounting systems in branch accounting? … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … 1.7 COMBINED FINANCIAL STATEMENTS: INVENTORY TRANSFERS AT HOME OFFICE COST 1.7.1 Producing Financial Statements for the Branch Before the branch prepares its closing entries and submits financial statements to the home office, it must verify that its home office equity account and shipments from home office account agree with the corresponding reciprocal accounts maintained by the home office. If the accounts do not agree, there are two possible explanations: 1. A transaction by one of the accounting entities has been improperly recorded by the other accounting entity. The accounting entity that made the error must make the appropriate adjusting entry. 2. A transaction initiated by one of the accounting entities has been recorded by the initiating entity but not yet by the receiving entity for example, cash transfers in transit, 9  inventory shipments in transit, and intra company charges. Normally, the receiving accounting entity prepares the adjusting entry as though it has completed the transaction before the end of the accounting period. Exhibit-1-2 Motta branch of TANA Company Financial statements Income statement Year ending December 31, 1998 Sales $ 120,000 Cost of goods sold (70,000) Selling expenses (16,000) Administrative expenses (14,000) Net income of branch 20,000 Home office account Year ending December 31, 1998 Account balance, January 1, 1998 $-0– Transfers from home office: Cash 28,000 Inventory 60,000 Expense allocations: Administrative 2,000 90,000 Transfers to Home office: Cash (10,000) Net income (above) 20,000 Account balance, December 31, 1998 100,000 10  Balance sheet December 31, 1998 Cash $ 30,000 Accounts receivable, net 41,000 Inventory: Acquired from vendors 8,000 Acquired from home office 25,000 Buildings and equipment, net 11,000 Total assets 115,000 Accounts payable and accruals 15,000 Home office equity (above) 100,000 Total liabilities and equity 115,000 Check your progress-3 If intra company accounts do not agree, what are some possible explanations? … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … 1.7.2 Producing Financial Statements for the Entire Company Once financial statements for the Motta branch have been developed, TANA Company can create a single combined set of statements for its entire organization. To achieve this objective, the simulated union of the accounting records for TANA Company’s home office and the Motta branch is presented in Exhibit 1-3 Generally accepted accounting principles require that in reporting the results of operations to its shareholders, the home combine the detail of the branch’s income or loss with the home office’s own accounts making up the net income or loss from home office’s own operations. This is accomplished by substituting the branch’s income statement for the branch income or loss account in the home office general ledger. Likewise, generally accepted accounting principles require that in reporting the balance sheet amounts to its shareholders, the home office combine the individual assets and liabilities of both accounting entities and report the combined amounts. This is accomplished by substituting the individual assets and liabilities of the branch for the Investment in Branch account. 11  Exhibit 1-3 TANA Company Work Sheet to Combine Home Office and Motta Branch Year Ended December 31, 1998 Home Elimination Income Statement B r a nc h Combined Office Dr. Cr. Sales $380,000 $120,000 $500,000 Cost of goods sold (210,000) (70,000) (280,000) Selling expenses (52,000) (16,000) (68,000) Administrative expenses (59,000) (14,000) (73,000) Interest expense (19,000) (19,000) Branch Income 20,000 20,000 -0- Income Before Income Taxes 60,000 20,000 20,000 60,000 Income tax (40%) (24,000) 24,000 Net Income 36,000 20,000 20,000 36,000 Statement of retained earnings Retained earning, Jan. 1, 1998 114,000 114,000 Home office equity (pre dosing) 80,000 80,000 -0- + Net income 36,000 20,000 20,000 36,000 - Dividends declared (10,000) (10,000) Balance, Dec. 31, 1998 140,000 100,000 100,000 140,000 Balance Sheet Cash 50,000 30,000 80,000 Accounts receivable, unit 60,000 41,000 101,000 Inventory 150,000 33,000 183,000 Land 22,000 22,000 Buildings and Equipment, net 118,000 11,000 129,000 Investment in Branch 100,000 100,000 -0- Total assets 500,000 115,000 100,000 515,000 Accounts payables and accruals 60,000 15,000 75,000 Long-term debt 200,000 200,000 Common stock 100,000 100,000 Retained earnings 140,000 140,000 Home Office Equity 100,000 100,000 -0- 500,000 115,000 140,000 515,000 12 1.8 COMBINED FINANCIAL STATEMENTS: INVENTORY TRANSFER ABOVE HOME OFFICE COST Inventory transfer can be priced at historical cost; however alternative procedures do exist. A company can elect to record merchandise shipments at the normal sales price, at its variable cost, at cost plus a predetermined mark up or at some other established value. Any time transfers are made at above cost, the home office must defer recognition of the mark up until the branch sells the inventory to its customers. To do otherwise would result in the recognition of profit from transferring inventory from one location to another in the company. To serve as an example assume that the inventory transferred to the branch from the home office in Exhibit 1.1 was marked up 20% over the home office’s cost of $60,000. In Exhibit 1.2, we assumed that the branch had a $33,000 ending inventory, of which $8,000 represented inventory obtained from home the office. In this case the branch’s ending inventory acquired from the home office is $30,000 ($25,000 + $5,000 mark up). Thus, the branch’s total ending should be adjusted downward to the amount that it would be if the inventory were transferred from the home office at cost. Ending inventory is $38,000 (30,000 + 8,000). Exhibit 1.4 shows the journal entries for the transfer of this inventory above cost, along with the appropriate year end closing and adjusting entries. The journal entries are numbered to correspond Exhibit 1.1, which shows inventory transfers made at the home office’s cost. 13  Exhibit 1.4 Home Office books Branch Books 2. Investment in Branch $72,000 2. Shipments from Home Office $72,000 Shipment to Branch 60,000 Home Office Equity 72,000 Unrealized Gain 12,000 Inventory Acquired from Vendors 8,000 12. Inventory 15,000 Inventory acquired from home office 30,000 Shipments to Branch 60,000 Cost of goods sold 77,000 Cost of goods sold 210,000 Shipments from home office 72,000 Purchases 285,000 Purchases 43,000 13. No entry 13. Sales 120,000 Cost of good sold 77,000 Selling expenses 16,000 Administrative expenses 14,000 Home office equity 13,000 14. Investment in Brach 13,000 14. No. Entry Branch income 13,000 Unrealized gain 7,000 Branch Income 7,000 14 When inventory transfers are made above home office’s cost, the branch’s cost of goods sold should be adjusted downward to the amount that it would be if the inventory were transferred from the home office at cost. The adjustment of the branch’s cost of goods sold equals the amount of the unrealized gain that was earned during the year and recognized by the home office. For TANA Company branch the adjustment will be as follows: Total unrealized gain at the time of inventory transfer to Branch................ $12,000 Unrealized gain related to ending inventory of Branch on Dec. 31, 1998 (30,000 – 30,000/1.2)........................................... (5,000) Realized gain during the year........................................................................... 7,000 Likewise, the branch’s ending inventory should be adjusted. In this case the adjustment is by the unrealized gain attributable to the ending inventory on the balance sheet date. For TANA Company’s branch the amount equals $5,000. Check Your Progress Exercise When inventory is transferred from home office to branch, what account will be debited in the books of the home office? … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ……… … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ……… … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ……… 1.9 SUMMARY Many businesses have operating units in more than one location. These units may be separate corporations, and a parent-subsidiary relationship exists between the parent company and its affiliated companies. In other cases the operating units are not incorporated but are part of one legal entity. In such an arrangement, each unit may be an agency of the main location (the home office) or it may be a branch office. A branch office may have its bookkeeping done at the home office based on transmittal forms summarizing the daily activities of the branch. Alternatively, a branch may keep its own books and accounts. 15 Shipments to a branch may be made at the home office’s cost or at an amount above its cost. 1.10 GLOSSARY Agency: An unincorporated unit that is an office in which orders are taken and then transmitted to the home office for processing, billing, and shipping merchandise. Branch: An incorporated operating unit that carries a complete inventory of its own from which it delivers merchandise to its customers. Unrealized profit in branch inventory: The dollar amount billed to the branch above the home office’s cost. 1.11 ANSWERS FOR CHECK YOUR PROGRESS EXERCISES Check Your Progress Exercise 1 1. An incorporated operating unit that carries a complete inventory of its own from which it delivers merchandise to its customers. 2. The main purposes of branch accounts are as follows: - Branch accounts helps to know the profit or loss of each branch. - It enables the head office to know the financial position of each branch. - It shows the requirements of goods or cash for each branch. - Branch account is the basis and helps the head office to control the activities of branch. - Suggestions and improvements are based on the branch accounts. Check Your Progress Exercise 2 Centralized accounting and decentralized accounting. Check Your Progress Exercise 3 A transaction by one of the accounting entities has been improperly recorded by the other accounting entity. A transaction initiated by one of the accounting entities has been 16 recorded by the initiating entity but not yet by the receiving entity for example, cash transfers in transit, inventory shipments in transit, and intra company charges. Check Your Progress Exercise 4 Investment in Branch. 1.12. MODEL EXAM QUESTIONS 1) The pre-closing general ledger trial balances at December 31, 19x5, for Baltimore Company and its Atlanta branch are shown below: Baltimore Company General Ledger Trial Balances December 31, 19 x 5 Home Office Branch Dr. (Cr.) Dr. (Cr.) Cash $36,000 $8,000 Accounts receivable 35,000 12,000 Inventory Home 70,000 Inventory Branch 15,000 Fixed Assets (net) 90,000 Investment in Branch 20,000 Accounts payable (36,000) (13,500) Accrued expenses payable (14,000) (2,500) Home office equity (9,000) Capital stock (50,0000 Retained Earnings (45,000) Home office Sales (440,000) Purchases 290,000 Expenses 44,000 Branch Sales (95,000) Purchases 24,000 Purchases from home office 45,000 Expenses 16,000 Total -0- -0- 17 Your audit disclosed the following: 1. On December 23, the branch manager purchased $4,000 of furniture and fixtures but failed to notify the home office. The bookkeeper, knowing that all fixed assets are carried on the home office books, recorded the proper entry on the branch records. It is the company’s policy to take any depreciation on assets acquired in the last half of a year. 2. On December 27, a branch customer erroneously paid his account of $2,000 to the home office. The bookkeeper made the correct entry on the home office books but did not notify the branch. 3. On December 30, the branch remitted cash of $5,000 which was received by the home office in January 19x6. 4. On December 31, the branch erroneously recorded the December allocated expenses from the home as $500 instead of $1,500. 5. On December 31, the home office shipped merchandise billed at $3,000 to the branch, which was received in January 19x6. 6. The entire beginning inventory of the branch had been purchased from home office. Home office 19x5 shipments to the branch were purchased by the home office in 19x5. The physical inventories at December 31,19x5 excluding the shipment in transit, are home office,$55,000(at cost); and branch ;$20,000 (composed of $18,00 from home office and $2,000 from outside vendors). 7. The home office consistently bills shipments to the branch at 20%above cost.The sales account is credited for the invoice price. Required (Disregard income tax) Prepare a worksheet showing Adjustments and Eliminations, Home office income statement, Branch income statement, and Combined Balance sheet. 2. The following information came from the books and records of MM Corporation and its branch. The balances as of December, 31, 19x2, the second year of operation’s existence. 18  Home office Branch Dr.(cr.) Dr.(cr.) Sales ($800,000) Expenses 275,000 Shipments to branch ($300,000) Unrealized profit in Branch inventory (65,000) The branch purchases all of its merchandise from the home office. The home office ships this merchandise at 120%of its cost. The ending inventory of the branch is $60,000 at the billed price. There are no shipments in transit between the home office and the branch. Required a) Compute the beginning inventory of the branch at the billed price. b) Compute the net income as reflected on the books of the branch. c) Prepare the entries on the books of the home office to record the true income of the branch. 19 UNIT 2: INTRODUCTION TO BUSINESS COMBINATION Contents 2.0 Aims and Objectives 2.1 Introduction 2.2 Overview of External Business Expansions 2.2.1 Terminology 2.2.2 Accounting Methods 2.3 Specific Terms and Provisions of the Acquisition Agreement 2.3.1 Types of Consideration Given 2.3.2 Types of Assets Acquired 2.3.3 Acquiring Assets Versus Common Stock 2.4 Resulting Organizational form of Acquired Business 2.4.1 Acquisition of Assets 2.4.2 Acquisition of Common Stock 2.5 Summary 2.6 Glossary 2.7 Answers for Check Your Progress Exercises 2.8 Model Exam Questions 2.0 AIMS AND OBJECTIVES When you have studied this unit you should be able to: o explain the alternatives for business combinations. o identify transactions as purchase or pooling of interests. o determine whether the company is subsidiary of another. o prepare entries to record combination. 20 2.1 INTRODUCTION Business combinations arise when one or more companies become subsidiaries of another company. Two different methods have been developed to account for business combinations, acquisition accounting and pooling of interests. This unit explains the need for business combination and the pooling of interest and the purchase methods of accounting. 2.2 OVERVIEW OF EXTERNAL BUSINESS EXPANSIONS As with any other economic activity, business combination can be part of an overall managerial activity to maximize shareholder value. Business combination is bringing together two or more separate businesses under common ownership. If the goal of business activity is to maximize the value of the firm, in what ways do business combinations help achieve that goal? Clearly the business community is moving rapidly toward business combinations as a strategy for growth and competitiveness. Size is obviously becoming critical as firms compete in today’s markets. Although no two business combinations are exactly alike, many share one or more of the following characteristics that potentially enhance profitability:  Vertical integration of one firm’s output and another firm’s distribution or further processing.  Cost saving through elimination of duplicate facilities and staff.  Quick entry for new and existing products into domestic or foreign markets.  Economics of scale allowing greater efficiency and negotiating power.  The ability to access financing at more attractive rates. As firms grow in size, negotiating power with financial institutions can grow.  Diversification of business risk. 21 Check You Progress Exercise 1 1. What is business combination? … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… …... 2. How business combinations enhance quick entry for new markets? … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… …... 2.2.1 Terminology A business combination refers to any set of conditions in which two or more organizations are joined together through common control. The company whose business is being sought is after called the target company. The company attempting to acquire the target company’s business is referred to as the acquiring company. The legal agreement that specifies the terms and provisions of the business combination is known as the acquisition, purchase, or merger agreement. The process of attempting to acquire a target company’s business is often called a takeover attempt. Business combinations can be categorized as vertical, horizontal, or conglomerate. Vertical combinations take place between companies involved in the same industry but at different levels. Horizontal combinations take place between companies that are competitors at the same level in a given industry. Conglomerate combinations involve companies in totally unrelated industries. 2.2.2 Accounting Methods The two basic methods of accounting for business combinations are the pooling of interests method and the purchase method. 22 i. The pooling of interests method. The theory underlying pooling of interests accounting is that a sale and purchase of a business have not occurred. Two companies have simply pooled their financial resources and managerial talents in such a manner that the owners of each of the separate business are now the owners of an enlarged business. All of the following 12 necessary and sufficient conditions must be met to use the pooling of interest method. 1. Each of the combining companies must be autonomous and must not have been a subsidiary or division of another corporation during the two-year period prior to the initiation of the combination plan. 2. At the dates the plan of combination initiated and consummated, each of the combining companies must be independent of the other combining companies. 3. The combination must be effected by a single transaction or in accordance with a specific plan within one year after the plan is initiated. 4. 90 percent or more of the outstanding common stock of a combining company must be exchanged for the voting common stock issued by the surviving or parent (issuing) corporation. 5. Each of the combining companies must maintain substantially the same voting common stock interest. 6. The combining companies may reacquire shares of voting common stock only for the purposes of other than business combination. 7. The ratio of the interest of an individual common stock holder to those of other stock holders in a combining company must remain the same as a result of the exchange of stock to effect the combination. 8. The voting rights of the common stock interests in the resultant combined corporation must be exercisable by the stockholders. 9. The combination must be resolved at the date the plan is consummated. 10. The combined corporation must not agree directly or indirectly to retire to reacquire all or part of the common stock issued to effect the combination. 11. The combined corporation must not enter into other financial arrangements for the benefit of the former stock holders of a combining company. 23  12. The combined corporation must not intend to dispose of a significant part of the assets of the combining companies within two years after the combination. Check Your Progress Exercise 2 1. What is the difference between horizontal and vertical combination? … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ….. 2. What is the theoretical rationale behind the pooling of interests method? … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ….. ii) The purchase method If the transaction does not qualify for pooling of interests treatment, then the purchase method must be used. The underlying concept of the purchase method is that one company has acquired the business of another company and a sale has occurred. This means that the stockholders of one combining company assume a dominant, controlling interest in the combined company while the stockholders of the other combining company do not participate in controlling the combined company. 2.3 SPECIFIC TERMS AND PROVISIONS OF THE ACQUISITION AGREEMENT 2.3.1 Types of Consideration Given The consideration given by the acquiring company can be cash, other assets, or issuance of debt, preferred stock, or common stock. Under the purchase method, the consideration may consist of various combinations of cash, debt, and common stock. As stated earlier, the consideration given in a transaction that qualifies for pooling of interests treatment is the acquiring company’s common stock. 24 2.3.2 Types of Assets Acquired Business may be acquired in one of two ways; the acquisition of assets or the acquisition of common stock. 1. The acquisition of assets. The acquiring company obtains the assets, and possibly liabilities, of the target company in exchange for cash, other assets, liabilities, stock, or a combination of these. The second organization normally dissolves itself as a legal corporation. 2. The acquisition of common stock. The acquiring company obtains more than 50% of the target company’s outstanding common stock for a business combination to have occurred. The original companies both dissolved, leaving only the new organization remaining in existence. 2.3.3 Acquiring Assets Versus Common Stock The following circumstances affect the determination of whether the acquiring compan y should acquire assets or common of the target company. i) Unrecorded liabilities: - If common stock is acquired, the buyer inherits responsibility for the unrecorded liabilities. By acquiring assets, however, the acquiring company can best insulate itself from responsibility for these contingencies, as much as a well-drafted acquisition agreement will clearl y specify those liabilities for which it assumes responsibility. ii) Non transferability of contracts: - If the target company’s contracts, leases, or operating rights cannot be transferred through the sale of assets, common stock must be acquired. iii) Ease of transfer: - Transferring stock certificate is easier than transferring assets. iv) Access to target company’s cash. The acquisition of the assets makes the target company’s cash and short term investment assets available to the acquiring company. 25 Check Your Progress Exercise –– 3 1. What types of consideration can be given under purchase accounting? … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ……… … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ……… … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ……… 2. What types of consideration can be given under pooling of interests accounting? … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ……… … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ……… … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ……… 2.4 THE RESULTING ORGANIZATIONAL FOR OF THE ACQUIRED BUSINESS Accounting for business combinations focuses on how the acquiring company initially records the transaction that brings about the combination. The detailed accounting entries for the acquiring company require substantial explanation under both the purchase method and the pooling of interests method: these are discussed in units 3 and 6 respectively. The following discussion is general in nature, so that an overall understanding can be grasped of the organizational effects of business combination. 2.4.1 Acquisition of Assets Assume A Company acquired all of the assets and assumed all of the liabilities of T Company by giving cash as the consideration. The following entries (in condensed format) would be made by each company. A company T company For the home office’s books Investment in T - - xx Cash - - - xx Cash - - - ---xx Assets --------- xx For the books of T Division of A company assets - - - - - - - - xx Liabilities - - xx Liabilities - - - - - ---xx Gain (a) ----------------- xx Home office equity - xx Loss (b) ----------------- xx 26 If cash exceeds book value of net assets. a) If cash is less than book value of net assets. 2.4.2 Acquisition of Common Stock A company owning more than 50% of the outstanding common stock of another company is referred to as the parent of that company. Conversely, a company whose outstanding common stock is more than 50% owned by another company is referred to as a subsidiary of that company. A subsidiary is a separate legal entity that must maintain its own general ledger. But only the acquiring company (the parent) must make an entry relating to the business combination. 1. Cash-for-stock exchange If the acquired company gives cash as consideration for the target company’s outstanding common stock, it makes the following entry. Investment in subsidiary ------ xx Cash ----------------------- xx. 2. Stock-for-stock exchange If the acquiring company issues shares of common stock to effect the business combination, the following entry would be made by the acquiring company. Investment in subsidiary ------ xx Common stock-------------------- xx Paid-in capital -------------------- xx This entry is slightly more involved in pooling of interests treatment applies (more about this in unit 6) 2.5. SUMMARY Business combinations are events or transaction in which two or more business enterprises, or their assets, are brought under common control in a single accounting entity. Purchase and pooling of interests are the two methods of accounting for business combination. 27 2.6 GLOSSARY - Acquiring company: - A company attempting to acquire the business of another company. - Acquisition agreement: - The legal agreement that specifies the terms and provisions of a business combination. - Horizontal combination: - A business combination that takes place between companies involved as competitors at the same level in a given industry. - Pooling of interest method: - A method of accounting for a business combination whereby the assets of the acquired business are carried forward to the combined corporation at their historical recorded amounts. - Purchase method: - A method of accounting for a business combination whereby the assets and liabilities of the acquired business are valued at their current values based on the considerations given by the acquiring company. - Vertical combination: - A business combination that takes place between companies involved at different levels in a given industry. 2.7 ANSWERS TO CHECK YOUR PROGRESS EXERCISES Check Your Progress Exercise –– 1 1. Business combination is bringing together two or more separate businesses under common ownership. 2. Business combination enhances quick entry into new markets by purchases part or whole of an existing business instead of starting from the scratch. Check your progress Exercise -2 1. Horizontal combination is between companies involved as competitors at the same level but vertical combination is between companies involved at different levels in a given industry. 2. The theoretical rationale behind the pooling of interests method is that a sale or purchase of a business have not occurred. 28 Check Your Progress Exercise 3 1. The consideration given can be cash, other assets, or assurance of debt, preferred stock, or common stock. 2. The consideration given under the pooling of interests method is the acquiring company’s common stock. 2.8 MODEL EXAM QUESTIONS A. PBX Company acquired all of the assets of Sprit Company by assuming all of its liabilities and paying $ 1,500,000 cash. Information with respect to sprit as the date of combination follows: Book Value Current Value Cash $ 10,000 $ 10,000 Accounts receivable, net (including$ 30,000 due from PBX Company) 90,000 90,000 Inventory 200,000 200,000 Land 400,000 500,000 Building and equipment 2,500,000 1,600,000 Accumulated depreciation (1,200,000) Total assets 2,000,000 2,400,000 Accounts payable and accruals 300,000 300,000 Long-term debt 800,000 800,000 Total liabilities 1,100,000 1,100,000 Common stock, $ 1 par value 100,000 Additional paid-in capital 500,000 Retained earnings 300,000 Total stockholders’ equity 900,000 1,300,000 Total liabilities and equity 20 00,000 2,400,000 Required 1. Does the acquisition appear to be a horizontal, vertical or conglomerate type of combination? 2. Would the transaction be accounted for as a purchase or a pooling of interests? 29 3. Is PBX Company the parent company of Sprit Company? Why or why not? 4. Is sprit a subsidiary? Why or why not? 5. Is sprit a separate legal entity after the transaction has been consummated? 6. Prepare the journal entry that would be made by sprit on the date of the combination. Assume a 40% tax rate. 7. Prepare a balance sheet for sprit after recording the entry in requirement 6. 8. Why did PBX pay $ 1,500,000 for a company whose net assets are worth only $ 1,300,000? 9. How would PBX have determined the current value of sprit’s net assets and liabilities? B. Assume the same information as in the above question(A), except PBX company gave as consideration 50,000 shares of its $ 10, par value common stock (of which 950,000 shares are all ready outstanding) having a market value of $ 30 per share. Assume that all conditions for pooling of interest are met. Required At what amount would PBX record the assets acquired from sprit 30  UNIT 3: THE PURCHASE METHOD OF ACCOUNTING AND CONSOLIDATED FINANCIAL STATEMENTS AT DATE OF ACQUISITION Contents 3.0 Aims and Objectives 3.1 Introduction 3.2 Essence of Purchase Method 3.3 Determining Total Cost of Acquired Business 3.4 The Relationship of Total Cost to Current Value of the Acquired Business’s Net Assets 3.5 Acquisition of Net Assets 3.6 Consolidated Financial Statements 3.6.1 Consolidation of Wholly Owned Subsidiary on Date of Purchase- type Business Combination 3.6.2 Consolidation of Partially Owned Subsidiary on Date of Purchase-type of Business Combination 3.7 Summary 3.8 Answers to Check Your Progress Exercises 3.9 Model Exam Questions 3.0 AIMS AND OBJECTIVE When you have studied this unit you should be able to:  prepare a consolidated balance sheet for combined companies.  compute good will at the date of acquisition. 3.1 INTRODUCTION Unit 2 introduced the purchase method and the pooling of interests method of accounting for business combinations. Because these two methods are conceptually opposite, they are best discussed and illustrated separately. Consequently, this unit and unit 4 and 5 cover the purchase method; unit 6 focuses on the pooling of interests method. 31 The purchase method can be applied to either form of business combination, the acquisition of assets and the acquisition of common stock. The procedures for preparing combined and consolidated balance sheets at the date of acquisition are dealt with in this unit. 3.2 ESSENCE OF THE PURCHASE METHOD The underlying concept of the purchase method of accounting is that one entity has purchased the business of another entity. The acquiring company records at its cost the assets or the common stock acquired. The cost is based essentially on the value of the consideration give. If the cost is above the current value of the target company’s net assets, then good will exists, which must be amortized over a period not to exceed 40 years. The total cost of the acquired business equals the sum of the following: 1. The fair value of the consideration given. 2. The direct costs incurred in connection with the acquisition. 3. The fair value of any contingent consideration that is given subsequent to the acquisition date. Check Your Progress Exercise –– 1 1. What is the essence of the purchase method of accounting? … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … 2. What are the costs of an acquiring company in a business combination accounted for by the purchase method? … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … … ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… ………… … 32 3.3 DETERMINING THE TOTAL COST OF THE ACQUIRED BUSINESS The cost of acquiring company in a business combination accounted for by the purchase method is the total of: (1) The amount of consideration paid, (2) The direct “out-of-pocket” costs of the combination, and (3) Any contingent consideration that is determinable on the date of the business combination. 1. 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, the current fair (or market) value of equity securities issued by the acquiring company. 2. Direct out-of-pocket costs Included in this category are some legal fees and some accounting fees. 3. 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. Contingent consideration that is determinable on the acquisition date is recorded that is determinable on the acquisition date is recorded as part of the cost of the combination; contingent consideration not determinable on the date of acquisition is recorded when the contingency is resolved and the additional consideration is paid or issued (or becomes payable or issuable). 3.4 THE RELATIONSHIP OF TOTAL COST TO CURRENT VALUE OF THE ACQUIRED BUSINESS’S NET ASSETS Once the total cost of the acquired business is determined, the next step in purchase accounting is to determine the current value of its assets and liabilities. The current value is then multiplied by the acquiring company’s ownership interest in the acquired business to obtain the acquiring company’s ownership interest in the current value of the net 33 assets. This amount is then compared to the total cost of the acquisition to determine if goodwill exists. Example On December 31, 1999 Silva corporation acquired Wabash company. Both companies used the same accounting principles for assets, liabilities, revenue, and expenses and both had a December 31 fiscal year. Silva issued 150,000 shares of its $ 10 per common stock (current fair value Br 25 a share) to Wabash’s sock holders for all 100,000 issued and outstanding shares of Wabash’s no-par, $10 stated value common stock. In addition, Silva paid $66,250 out-of-pock costs for the business combination. Immediately prior to acquisition, Wabash’s condensed balance sheet was as follows: Wabash Company. Balance sheet (prior to business combination) December 31, 1999. Assets Current assets -------------------B Br. 1, 000,000 Plant assets ---------------------------3,000,000 Other assets - - - - - ------------- - 600,000 Total assets --------------------------- 4,600,000 Liabilities and stockholders’ equity Current liabilities ------------------ Br 500, 000 Long-term debt ----------------------- 1,000,000 Common stock, no-par, $10 stated value ---------------------- 1,000,000 Additional paid-in capital ------------ 700,000 Retained earnings -------------------- 1,400,000 Total liabilities and Stock holders’ equity 4,600,000 The board of directors of Silva Corporation determined the current fair values of Wabash Company’s identifiable assets and liabilities as follows: 34  Current assets ----------------------- Br.1, 150,000 Plant assets ------------------------------- 3,400,000 Other assets ---------------------------------- 600,000 Current liabilities ------------------------- (500,000) Long-term debt (present value) --------- (950,000) Total identifiable net asset-------------- 3, 700,000 The condensed journal entries that follow are required for Siwa Corporation to record the acquisition of Wabash on December 31, 1999, as purchase-type of business combination. Silva Corporation. Journal entries December 31, 1999. Investment in Wabash company common stock (150,000 x Br.25)--------------------------------- 3,750,000 Common stock (150,000 x 10) ----------------------------- 1,500,000 Paid – In capital in excess of par ---------------------------- 2,250,000 To record the acquisition of Wabash as purchase Investment in Wabash company common stock --------------------------- 66,250 Cash 66,250 To record payment of out-of-pocket costs of business combination Current assets ------------------- 1,150,000 Plant assets 3,400,000 Other assets 600,000 Discount on long-term bond 50,000 Goodwill 116,250 Current liabilities 500,000 Long-term debt 1,000,000 Investment in Wabash Company Common stock (3,750,000 + 66,250) 3,816,250 To allocate total cost of acquisition to identifiable assets and liabilities, with the reminder to goodwill 35 Amount of goodwill is computed as follows: Total cost (Br.3, 750,000 + 66,250) - - - - $3,816, 250 Less: carrying amount of Wabash’s Identifiable net assets (Br4, 600,000 – $ 1,500,000) $3,100,000 Excess (deficiency) of current fair values of identifiable net assets over carrying amounts: Current assets - - - - - - - 150,000 Plant assets - - - - - - - - - 400,000 Long-term debt - - - - - - - - 50,000 3,700,000 Amount of goodwill $116,250 3.5 ACQUISITION OF NET ASSETS The acquisition of assets is merely the purchase of the target company’s assets. Part of the purchase price takes the form of assuming responsibility for the target company’s existing liabilities. Each asset and liability is recorded at its current value. 3.6 CONSOLIDATED FINANCIAL STATEMENTS Consolidated financial statements are similar to the combined financial statements described in unit 1 for a home office and its branches. Assets, liabilities, revenues, and expenses of the parent company and its subsidiaries are totaled; inter-company transactions and balances are eliminate; and the final consolidated amounts are reported in the consolidated balance sheet, income statement, stockholders, equity, and statement of cash flows. Consolidated financial statements are issued to report the financial position and operating results of a parent company and its subsidiaries as though they comprised a single accounting entity. 36  Definition A parent is an enterprise that has one or more subsidiaries. Definition A subsidiary is an enterprise that is controlled by another enterprise (known as the parent). Definition Control is the power to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities. This state of affairs requires a parent company generally to produce consolidated financial statements showing the position and results of the whole group. An investor’s direct and indirect ownership of more than 50% of an investee’s outstanding common stock has been required to evidence the controlling interest underlying a parent-subsidiary relationship. 3.6.1. Consolidation of Wholly Owned Subsidiary on Date of Purchase-type Business Combination There is no question of control of a wholly owned subsidiary. Thus, to illustrate consolidated financial statements for a parent company and a wholly owned purchased subsidiary, assume that on December 31, 1999 palm corporation issued 10,000 shares of its $10 par common stock (current fair value $45 per share) to stockholders of Starr company for all outstanding $5 par common stock of star. There was no contingent consideration. Out-of-pocket costs of business combination paid by palm for finder’s and legal fees on December 31, 1999 amount $50,000. Assume also that the business combination qualified for purchase accounting because required conditions for pooling accounting were not met, both companies had a December 31, 1999 fiscal year and used the same accounting principles and procedures. The balance sheets of Palm Corporation and star company for the year ended December 31, 1999 follow: Assets palm corporation star company Cash $ 100,000 $40,000 Inventories 150,000 110,000 Other current assets 110,000 70,000 37 Receivable from star company 25,000 Plant assets (net). 450,000 300,000 Patent (net) 20,000 Total assets $ 835,000 540,000 Liabilities and stockholders’ equity Payable to palm corporation $25,000 Income taxes payable. $26,000 10,000 Other liabilities 325,000 115,000 Common stock, $10 par 300,000 Common stock, $5 par 200,000 Additional paid-in capital. 50,000 58,000 Retained earnings 134,000 132,000 Total liabilities stockholders equity. $835,000 $540,000 On December 31,199, current fair values of star company’s identifiable assets and liabilities were the same as their carrying amounts, except for the three assets listed below. Current fair values December 31, 1999. Inventories $135,000 Plant assets (net). 365,000 Patent (net) 25,000 Prepare the consolidated balance sheet at 31 December 1999. Answer Palm Corporation recorded the combination as a purchase on December 31, 1999, with the following journal entries: Investment in star common stock (10,000 x $ 45) 450,000 Common stock (100,000 x $ 10 100,000 Paid-in capital in excess of par 350,000 38 To record issuance of 10,000 shares of common stock for all the outstanding common stock of star in a purchase type business combination. Investment in star company common stock 50,000 Cash 50,000 To record out-of-pocket costs of business combination with star company After the forgoing journal entries have been posted, the affected ledger accounts of Palm Corporation are as follows: Cash Balance forward $ 100,000 50,000 out-of-pocket Costs of business combination Balance 50,000 Investment in star company common stock $ 450,000 issuance of common stock 50,000 direct out-of-pocket costs of business combination 500,000 balance. Common stock 300,000 balance forward, 100,000 issuance of common stock in business combination 400,000 balance Paid-in capital in excess of par $ 50,000 balance forward 350,000 issuance common stock in business combination 400,000 balance. Now we can prepare the following consolidated balance sheet. 39  Consolidated balance sheet December 31, 1999 Assets Cash ($ 50,000 + 40,000) $ 90,000 Inventories ($ 150,000 + 135,000) 285,000 Other current asset ($ 110,000 + 70,000) 180,000 Plant assets (net) ($ 450,000 + 365,000) 815,000 Patent (net) (0 + $ 25,000) 25,000 Goodwill (net) 15,000 Total assets $ 1,410,000 Liabilities and stockholders’ equity Income-tax payable ($ 26,000 + 10,000) $ 36,000 Other liabilities ($ 325,000 + 115,000)