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Chapter 2 - Lectures notes
Financial Reporting III (ACCO 420)
Concordia University
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EXERCISE 2-
(a) Acquisition analysis Consideration transferred:
Shares: 100,000 × 10 × $10 = $10,000, Patent 1,000, Cash: 100,000 × $5 = 520, $11,520,
Fair value of identifiable assets and liabilities acquired:
Current assets $980, Non-current assets 4,220, 5,200, Liabilities 500, $4,700,
Goodwill = $11,520,000 – $4,700,000 = $6,820,
(b) Journal entries: Lai Hing Ltd
Current assets 980, Non-current assets 4,220, Goodwill 6,820, Liabilities 500, Patent 350, Share capital 10,000, Gain on sale of patent 650, Cash 520, (Acquisition of Sound Ltd)
Acquisition-related expenses 10, Cash 10, (Payment of costs associated with the acquisition to former shareholders)
Share capital 500 Cash 500 (Costs of issuing shares)
EXERCISE 2-
(a) Consideration transferred = 100,000 × $1. = $190, Net fair value of identifiable assets and liabilities of Dory Ltd. = $175,
Goodwill = $190,000 – $175, = $15,
The journal entries at acquisition date, December 1, 2019 are:
Cash 50, Furniture & fixtures 20, Accounts receivable 5, Property, plant, and equipment 125, Goodwill 15, Accounts payable 15, Current tax liability 8, Provision for vacation pay 2, Share capital 190, (To record the acquisition of Dory Ltd. by Meeru)
Note Disclosure: description of the transactions
(b) At December 31, 2019, the provisional amounts must be used as per journal entries in part (a).
In 2020, the carrying amount of the plant must be calculated as if its fair value at the acquisition date had been recognized from that date, with an adjustment to goodwill. The plant increased by $6,000 from the estimated value. This means that Goodwill will decrease by $6,000.
If the plant had a 5-year life from acquisition date, Dory Ltd would have charged depreciation for 1 month in 2019. Extra depreciation of $100 is required (calculated as 1/5 × 1/12 × $6,000).
The adjusting entry at March 1, 2020 is:
Goodwill = $895,679 – $526,288 = $369,
Accounts Receivable 145, Inventory 245, Property Plant and equipment 501, Goodwill 369, Accounts payable 167, Long term debt 199, Cash 895,
PROBLEM 2-
BILLIARDCO – QTECH LTD
Acquisition analysis
Consideration transferred
= $20,000 (cash)
- $40,000 (shares: 16,000 × $2) = $60, (a) Journal entries: Billiardco
Net fair value of identifiable assets and liabilities acquired:
Property, plant, and equipment $30, Inventory 28, Accounts receivable 20, 78, Accounts payable 20, $58,
Consideration transferred = $60, Net fair value of identifiable assets and liabilities acquired =
$58,
Goodwill = $2,
The journal entries are:
Property, plant and equipment 30, Inventory 28, Accounts receivable 20, Goodwill 2, Accounts payable 20, Payable to Qtech 20, Share capital 40, (Net assets acquired from Qtech Ltd. and issue of shares)
Payable to Qtech Ltd 20, Cash 20, (Payment of cash consideration)
Acquisition-related expenses 500 Cash 500 (Payment of acquisition-related costs)
Share capital 400 Cash 400 (Share issue costs)
(a) Billiardco
Statement of Financial Position
Current Assets
Cash ($30,000 – $20,000 – $500 – $400) $9, Accounts receivable ($8,000 + $20,000) 28, Inventories ($14,000 + $28,000) 42, Total Current Assets $79, Non-current Assets
Property, plant and equipment ($50,000 + $30,000)
$80,
Government bonds 12, Goodwill 2, Total Non-current Assets 94, Total Assets $173,
Shares: 2/3 × 60,000 × $3. $128, Cash Accounts payable ($43,500 + $1,600) $45, Mortgage and interest ($40,000 + $4,000) 44, Bonds and premium 52, Liquidation expenses 2, 144, Cash held by F-Squared (12,000) 132, $260,
Gain on bargain purchase = $289,700 – $260, = $29,
Property, plant, and equipment 46, Inventory 39, Buildings 40, Accounts receivable 34, Land 130, Gain on bargain purchase 29, Cash 132, Share capital 128, (Net assets acquired from F-Squared Ltd. and issue of shares)
Share capital 1, Cash 1, (Costs of issuing shares)
PROBLEM 2-4 (Continued)
(b)
Hastings Ltd.
Statement of Financial Position
Current Assets
Cash ($23,000 - $132,000 - $1,200) $(110,200) Accounts receivable ($25,000 + $34,700) 59, Inventories ($35,500 + $39,000) 74, Total Current Assets $24,
Non-current Assets
Property, plant, and equipment ($65,000 + $46,000)
111,
Buildings ($60,000 + $40,000) 100, Land ($150,000 + $130,000) 280, Goodwill 25, Total Non-current Assets 516, Total Assets $540, Shareholder’s Equity and Liabilities
Current Liabilities
Accounts payable 56,000 $56, Non-current liabilities Mortgage loan $50, Bonds 100, Total Non-current liabilities $150,
Total Liabilities $206, Equity
Share capital ($100,000 + $128,000 – $1,200) $226, Retained earnings ($77,500 + $29,700) 107, Total Equity $334, Total Liabilities and Shareholder’s Equity $540,
(d) Consideration transferred = 100,000 × $1. = $170, Net fair value of identifiable assets and liabilities of Dory Ltd = $175, Gain on bargain purchase = $175,000 – $170, = $5,
The journal entries at acquisition date, December 1, 2019 are:
Cash 50,
Furniture &fixtures 20,
Accounts receivable 5,
Property, plant, and equipment 125,
Accounts payable 15,
LING LTD
(Payment of the consideration transferred)
MORWONG LTD
Journal Entries
Loan—Long Cloud 52, Retained earnings 125, (Transfer of assets and liabilities) Land 120, Delivery trucks 28, Cash 23, Receivable from Ling Ltd 171, (Receipt of purchase consideration)
Retained earnings 1, Liquidation expenses payable 1, (Expense payable)
Liquidation expenses payable 1, Accounts payable 23, Cash 25, (Payment of outstanding debts)
Share capital 60, Retained earnings 156,
Shareholders’ distribution dividend payable 216, (Transfer of share capital and RE)
Shareholders’ distribution payable 216, Land 120, Motor vehicle 32, Delivery trucks 64, (Transfer of assets to shareholders)
ZANADU LTD – CORION LTD
Acquisition Analysis - Accounts receivable 15, Journal Entries - Land 120, - Buildings 40, - Cultivation equipment 40, - Irrigation equipment 22, - Goodwill 101, - Loss on disposal of the trucks 2, - Loan—Bank of NB 80, - Loan—Farinacci Bros 35, - Loan—Long Cloud 52, - Land 50, - Gain on disposal of land 70, - Trucks 30, - Payable to Morwong Ltd 23, - Payable to Morwong Ltd 23, (Acquisition of net assets of Morwong Ltd) - Cash 23,
- Receivable from Ling Ltd 171, (b) - Accounts receivable 15, - Land 100, - Buildings 30, - Cultivation equipment 46, - Irrigation equipment 22,
- Loan—Bank of NB 80,
- Loan—Farinacci Bros 35,
- PROBLEM 2- - Accounts receivable $125, Net fair value of identifiable assets and liabilities acquired: - Land 840, - Buildings 550, - Farm equipment 364, - Irrigation equipment 225, - Vehicles ($172,000 – $48,000) 124, - 2,228, - $2,148, Accounts payable (80,000) - Shares: 100,000 × $14 per share$1,400, Consideration transferred: - $615, Cash: ($480,000 +$5,500 +$150,000 – $20,000) - Land: 220, - $2,235,
- Goodwill $2,235,500 – $2,148,000 = $87,
- Accounts receivable 125, The journal entries in Zanadu Ltd are:
- Land 840,
- Buildings 550,
- Farm equipment 364,
- Irrigation equipment 225,
- Vehicles 124,
- Goodwill 87,
- Accounts payable 80,
- Share capital 1,400,
- Cash 615,
- Land 80,
- Gain on sale of land 140,
- Accounts payable 80,
Acquisition-related expenses 25, Cash 25, (Payment of acquisition-related costs)
Share capital 18, Cash 18, (Share issue costs)
PROBLEM 2-
TAILOR LTD – FLATHEAD LTD – FLEXON LTD
(a) Acquisition Analysis – Tailor Ltd – Flathead Ltd
Consideration transferred
Shareholders Shares Shares of Flathead Ltd 150, Shares in Tailor Ltd (1/3) = 50,000 × $2 $125, Shares in Listed Companies
15,
Creditors Cash Accounts payable $49, Mortgage loan 30, Liquidation costs 8, Accrued vacation pay 29, Total cash required 117, Less cash already held (5,200) 112, $252,
Fair value of identifiable assets and liabilities acquired
Accounts receivable $21, Inventory 26, Land and buildings 80,
Share capital 75, Cash 45, (Acquisition of shares in Flexon Ltd)
b) Goodwill is measured differently for two reasons:
a) It is prohibited to recognize internally generated goodwill so the figure recorded in the books of Flathead Ltd does not represent the total goodwill of the company as at acquisition date. b) Goodwill cannot be separated from the company and sold separately so no fair value is available. The only way goodwill can be measured is to compare the total value of the company against the fair values of its identifiable net assets, any surplus is deemed to represent the value of the net unidentifiable assets or goodwill.
(c) The journal entry to record the dividend cheque is: Cash 1, Dividend revenue 1, (Dividend received from Flexon Ltd)
All dividends are treated as revenue by the acquirer regardless out of which equity the dividend is paid.
(d) Tailor Ltd should post the following journal:
Goodwill 25, Cash 25, (Payment to Flathead Ltd)
If the liability had been identified at acquisition date then Tailor Ltd would have paid an extra $25,000 cash to acquire the assets of Flathead Ltd. As the cost of the combination has increased but there has been no change in the fair values of identifiable assets and liabilities, then the value of goodwill acquired must increase.
WRITING ASSIGNMENT 2-
Arguments in favour of expensing the acquisition related costs: These costs are not part of the fair value exchange between the buyer and the seller. They are separate transactions for which the buyer pays the fair value for the services received. The services received from the outlays have been consumed, and so do not give rise to assets.
Arguments against expensing:
The contract to be Wearhuis’ exclusive supplier of sporting goods, whether cancellable or not, meets the contractual-legal criterion. Additionally, because Total Sporting Goods establishes its relationship with Wearhuis through a contract, the customer relationship with Wearhuis meets the contractual-legal criterion. Because Total Sporting Goods has only one customer relationship with Wearhuis, the fair value of that relationship incorporates assumptions about Total Sporting Good’s relationship with Wearhuis related to both sporting goods and electronics. However, if Divestex Ltd. determines that the customer relationships with Wearhuis for sporting goods and for electronics are separate from each other, Divestex Ltd. would assess whether the customer relationship for electronics meets the separability criterion for identification as an intangible asset (because there is no contractual- legal agreement)
Regardless of whether they are cancellable or not, the purchase orders from 60% of TransOntario’s customers meet the contractual-legal criterion. Additionally, because TransOntario has established its relationship with 60% of its customers through contracts, not only the purchase orders but also TransOntario’s customer relationships meet the contractual-legal criterion. So the backlog for these custumers is an identifiable asset to recorded at fair value (actual and future purchase orders) by Jiwaji. Because TransOntario has a practice of establishing contracts with the remaining 40% of its customers, its relationship with those customers also arises through contractual rights and therefore meets the contractual-legal criterion even though TransOntario does not have contracts with those customers at December 31, 2019. So the agreement is an identifiable asset to be recorded at fair value (of the future purchases orders) but it could also be argued that they are not identifiable and be a component of Goodwill.
Because Financeco establishes its relationships with policyholders through insurance contracts, the customer relationship with policyholders meets the contractual-legal criterion. So the policies are an identifiable asset to be recorded at fair value. IAS 36 Impairment of Assets and IAS 38 Intangible Assets apply to the customer
relationship intangible asset due to the possibility of cancellation.
CASE 2-
CC acquired 220 leasehold interests from MC and their online store. They intend to use the locations purchased to eventually open CC stores in Eastern Canada, in addition to the website that was purchased.
CC must maintain the net income and equity figures for the debt to equity covenant imposed by the lender who assisted with financing this acquisition.
The CFO of CC thought that this transaction could be accounted for as a business combination. In doing so, the identifiable assets acquired, the leasehold interests
and the website, would be measured at their acquisition date fair values and any goodwill or gain from bargain purchase would be recognized. By recognizing goodwill, which is not amortized but rather is tested for impairment on annual basis, by not amortizing it or expensing it immediately the equity figure would be more favourable. Similarly, by recognizing a gain from bargain purchase, it would be recognized in net income immediately and it would positively impact the equity and net income figures.
However, it must be assessed if this transaction meets the conditions to be a business combination, whereby what was acquired constitutes a business or if the assets acquired are not a business, if it should be accounted for as an asset acquisition.
A business combination is a transaction in which an acquirer, in this case CC, acquires control of a business. Must assess if CC has obtained control and if a business has been acquired.
A reporting entity controls another entity when they have the power to direct its activities so as to generate returns for the reporting entity. CC has obtained control of the leasehold interests and website of MC as they are changing the activities so as to obtain benefits from it. However, must assess if these activities constitute a business or are simply an acquisition of assets.
A business is an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return directly to owners or investors. A business consists of inputs and processes applied to those inputs that have the ability to create outputs. A business need not include all of the inputs or processes that the seller (MC) used in operating that business if market participants are capable of acquiring the business and continuing to produce outputs, for example by integrating the business with their own inputs and processes.
What CC acquired from MC are the leases for 220 of their 279 locations and their online website. Do these leases constitute a business (are there input, processes, and outputs) or are they an intangible asset- the favourable leases and the online site? It could be viewed that they did not buy the MC business since they did not buy the MC brand. However, the major value in MC are the lease locations. By not using the name brand MC to carry on the business subsequent to the acquisition, could conclude that the business itself is not being acquired and that it is only the assets they have purchased. However, part of what they paid for is the elimination of the competition called MC. In addition, the remaining stores are being wound up subsequent to the acquisition by CC and CC plans to start operating their own book stores within the 220 leasehold interests they acquired, which could be viewed as CC having bought a business.
Chapter 2 - Lectures notes
Course: Financial Reporting III (ACCO 420)
University: Concordia University
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