CHAPTER 3 HOMEWORK SOLUTIONS

SOLUTIONS TO REVIEW QUESTIONS

1. The key element that must be present in a business combination is one company gaining
control of another business.
2. For a subsidiary to be consolidated, the parent must control the subsidiary. An investor
controls an investee when it is exposed, or has rights, to variable returns from its
involvement with the investee and can affect those returns through its power over the
investee.
3. A parent may have control of a subsidiary without having greater than 50% of the voting
shares when it holds irrevocable agreements, convertible securities, and/or warrants,
which give the parent the power to direct the activities that most significantly affect the
returns of the subsidiary.
4. Protective rights are rights granted to an individual or entity to protect their interest in an
entity without granting them control. For example, a stakeholder might be granted the
right to veto certain decisions that do not affect the current ability to direct the activities
that most significantly affect the returns of the other entity. Similarly, a creditor for
example may be granted the right to remove management and/or the Board of Directors if
the entity has entered bankruptcy. Any right granted to a stakeholder must be evaluated
to determine the extent to which it may give that stakeholder control over the entity.
Although protective rights are not intended to grant control over the entity to which the
rights relate, they must be evaluated to determine if they give the holder the power to
direct the activities that most significantly affect the returns of the other entity. To the
extent that they do, they may indeed result in control. Alternatively, they may give the
holder significant influence over the strategic operating and financing decisions of the
entity. In any case, it is always important to take into consideration any rights, contractual
or otherwise, that may impact the decision making of an entity when determining which
party controls that entity.
5. A statutory amalgamation is a legal form of a business combination, whereby only one of
the companies involved survives. Therefore, it is really a purchase of net assets with
voting shares as the means of payment.
6. If the means of payment is cash, the company that makes the payment is identified as the
acquirer. If the means of payment is the issue of shares, an examination is made as to the
extent of the shareholdings of two distinct groups of shareholders. If the shareholders of
one of the combining companies as a group hold greater than 50% of the voting shares of
the combined company, that company is identified as the acquirer. When an acquirer
cannot be determined in this manner, an additional examination is made of the
composition of the board of directors and the management of the combined company to
determine who has the current ability to direct the activities that most significantly affect
the returns of the investee. Often (but not always) the acquirer is the larger company, and
the company that issues the shares.
7. The acquisition cost is often greater than the carrying amount of the acquiree’s assets and
liabilities for two reasons. First, the fair value of the acquiree’s identifiable assets is often
greater than the carrying amounts, especially when the assets are reported by the
acquiree at historical cost. Secondly, the acquiree may have an additional value over and
above the fair value of its identifiable net assets because of its earnings potential. This
additional value is referred to as goodwill. Like many other assets, goodwill is recognized
at cost when it is purchased. It is not recognized as it is developed.
8. Goodwill is the excess of the total consideration given by the parent and noncontrolling
interest, if any, over the fair value of the identifiable net assets. Goodwill represents the
amount paid for excess earnings power due to reputation and employee workforce, etc.
9. An intangible asset should be recognized apart from goodwill when it either meets the
contractual-legal criterion or the separability criterion. That is:
(a) the asset results from contractual or other legal rights (regardless of whether those
rights are transferable or separable from the acquired enterprise or from other rights and
obligations); or
(b) the asset is capable of being separated or divided from the acquired enterprise and
sold, transferred, licensed, rented, or exchanged (regardless of whether there is an intent
to do so).
Otherwise, it should be included in the amount recognized as goodwill.
10. If the other company can continue as a single shareholder of the issuing company, it may
be able to dominate. When this other company is wound up, the shares of the issuing
company are distributed to the shareholders of this other company, and domination by one
or two shareholders is thus less likely.
11. Acquisition cost consists of the sum of the cash paid, the present value of any debt
instruments issued, the fair value of any shares issued, and the fair value of any
contingent consideration if determinable. This total acquisition cost is compared with the
fair value of the identifiable assets less the fair value of the identifiable liabilities of the
acquired company. If the acquisition cost is greater than the fair value of the identifiable
net assets acquired, the excess is recorded as goodwill. If the acquisition cost is less than
the fair value of the identifiable net assets acquired, the result is negative goodwill, which
is recognized as a gain on purchase. The balance sheet immediately after the business
combination consists of the carrying amount of the assets and liabilities of the acquiring
company, plus the carrying amount of the assets and liabilities of the acquired company,
plus the acquirer's share of the excess of the fair values of the assets and liabilities of the
acquired company over their related carrying amount, plus any goodwill that arose on the
combination. Shareholders' equity is that of the acquirer. Subsequent net income consists
of the acquirer's net income plus the acquirer's share of the net income of the acquiree
earned since acquisition date, subject to some adjustments (for the amortization of the
acquisition differential.)
12. An acquisition differential is the difference between total consideration given by the parent
and noncontrolling interest, if any, and the carrying amounts of the net assets and
liabilities of its subsidiary. It does not appear on the consolidated balance sheet as a single
amount, but rather is distributed to individual identifiable assets and liabilities of the
subsidiary so that these assets and liabilities are measured at fair value, and any positive
remaining balance is reflected as goodwill. Negative balances remaining are recognized
on the income statement as gains on the date of acquisition.
13. Fair value reporting takes precedence over the historical cost principle when reporting the
subsidiary’s identifiable assets and liabilities under the acquisition method because those
assets and liabilities are reported at their fair values regardless of the amount paid by the
parent.
14. No. If the subsidiary used push-down accounting, the fair value differences would be
recorded in the records of the subsidiary as at the date of acquisition. Consolidation would
then be the simple procedure of combining like items from the parent's and subsidiary's
statements.
15. Under the new entity method, the net assets of both the acquirer and acquiree are brought
into the combination at their fair values. The justification for this treatment is that a new
 entity has been created and fair value is the most appropriate representation for the new
entity.
16. Separate financial statements are separate-entity financial statements of the parent that
do not include the consolidation of all controlled subsidiaries. A parent may present
separate financial statements if:
1) the parent itself is a wholly or partially owned subsidiary of another entity and that
entity consents to having separate financial statements presented;
2) the parent’s debt/equity instruments are not traded in any public market;
3) the parent did not, or is not in the process of, filing financial statements with any
exchange commission for raising funds publicly; and
4) the ultimate or intermediate parent of the parent produces financial statements that are
publicly available and prepared in accordance with IFRS.
17. The debt-to-equity ratio for consolidated financial statements will typically be higher than
the debt-to-equity ratio for the parent’s separate entity financial statements. The
subsidiary’s debt is included on the consolidated financial statements but not on the
parent’s separate entity financial statements. Equity is the same amount for both the
consolidated and separate entity financial statements for a wholly owned subsidiary.

18. IFRS requires that a parent consolidate its subsidiaries. Under ASPE, an enterprise shall
make an accounting policy choice to either consolidate its subsidiaries or report its
subsidiaries using either the equity method or the cost method. All subsidiaries should be
reported using the same method. When a subsidiary’s equity securities are quoted in an
active market and the parent would normally choose to use the cost method, the
investment should not be reported at cost. Under such circumstances, the investment
should be reported at fair value, with changes in fair value reported in net income.
IFRS does not allow push-down accounting. ASPE allows push-down accounting, but the
entity must disclose the amount of the change in each major class of assets, liabilities, and
shareholders’ equity in the year that push-down accounting is first applied.

19. A reverse takeover occurs when one company acquires the shares of another company by
issuing enough of its own shares as payment so that the shareholders of the other
company end up being in control of the combined company. It is often used by a nonpublic
company as a device to obtain a stock exchange listing without having to go through the
formalities of an exchange's listing procedures. A takeover of a public company is
 arranged in such a way that the public company being taken over becomes the legal
parent while the nonpublic company is the parent in substance.
20. A Company issues shares to acquire B Company such that the shareholders of B
Company end up holding the majority of the shares of A Company (for example, 75%).
Because B Company is the deemed acquirer, the acquisition cost is determined as if B
Company had issued shares to the shareholders of A Company. A calculation is made to
determine how many shares B Company would have had to issue so that its existing
shareholders would end up holding 75% of its outstanding shares. This calculated number,
multiplied by the fair value of B Company's shares, becomes the acquisition cost.
SOLUTIONS TO PROBLEMS

Problem 3-1
(a)
Journal entry on Lanigan’s books

Cash and receivables 155,000

Inventory 110,000
Buildings and equipment 200,000
Current liabilities 85,000
Long-term debt 130,000
Cash 250,000

Journal entry on Macklin’s books

Cash 250,000
Current liabilities 85,000
Long-term debt 130,000
Cash and receivables 155,000
Inventory 110,000
Buildings and equipment 200,000

(b) Lanigan Macklin

Cash and receivables $ 507,000 $ 250,000

Inventory 320,000 0
Buildings and equipment (net) 520,000 0
$1,347,000 $250,000

Current liabilities $ 277,000 $ 0

Long-term debt 480,000 0
Common shares 200,000 110,000
Retained earnings 390,000 140,000
 $1,347,000 $250,000

Problem 3-2
(a)
Journal entry on Rodriguez’s books

Investment in Vancouver 230,000

Cash 230,000

There would be no journal entry on Vancouver’s books because the transaction was with the
shareholders of Vancouver and not with Vancouver.

(b) Rodriquez Vancouver

Cash and receivables $ 71,000 $ 55,000

Inventory 105,000 140,000
Property and equipment (net) 160,000 270,000
Investment in Vancouver 230,000 0
$566,000 $465,000

Current liabilities $ 96,000 $ 110,000

Long-term debt 175,000 125,000
Common shares 100,000 150,000
Retained earnings 195,000 80,000
$566,000 $465,000

(c) Rodriquez

Cash and receivables $ 126,000

Inventory 245,000
Property and equipment (net) 430,000
$801,000

Current liabilities $ 206,000

Long-term debt 300,000
Common shares 100,000
Retained earnings 195,000
$801,000

Problem 3-3
(a)
Journal entry on Abdul’s books

Cash and receivables 20,150

Inventory 10,050
Plant assets 70,100
Goodwill (plug) 19,100
Current liabilities 27,600
Long-term debt 33,800
Cash 58,000

Journal entry on Lana’s books

Cash 58,000
Current liabilities 27,600
Long-term debt 40,100
Cash and receivables 20,150
Inventory 8,150
Plant assets 66,350
Gain on sale of net assets 31,050

(b) Abdul Lana

Cash and receivables $ 55,150 $ 58,000

Inventory 70,550 0
Plant assets (net) 306,100 0
Goodwill 19,100 0
 $450,900 $58,000

Current liabilities $ 93,100 $ 0

Long-term debt 128,050 0
Common shares 140,500 40,050
Retained earnings (deficit) 89,250 17,950
$450,900 $58,000

Problem 3-4
Acquisition cost (300,000 shares  $9.00) $2,700,000 (a)

Fair value of net assets 2,290,000

Favourable lease contract** 60,000 (b)

Goodwill $350,000 (c)

** IFRS 3 requires favourable lease terms to be recognized at fair value as an identifiable asset
in a business combination (par. B29 to B31). Note that the fact that the lease cannot be
transferred or assigned does not affect the requirement to recognize it as an identifiable asset
on acquisition as it still meets the contractual-legal criterion (i.e. the asset results from
contractual or other legal rights (regardless of whether those rights are transferable or separable
from the acquired enterprise or from other rights and obligations).

D Ltd.

Balance Sheet

July 1, Year 5

Current assets (450,000 + 510,000) $ 960,000

Noncurrent assets (4,950,000 + 3,500,000) 8,450,000

Intangible asset – lease contract (b) 60,000

Goodwill (c) 350,000

$9,820,000

Current liabilities (600,000 + 800,000) $1,400,000

Long-term debt (1,100,000 + 920,000) 2,020,000

Common shares (2,500,000 + (a) 2,700,000) 5,200,000

Retained earnings 1,200,000

$9,820,000

Problem 3-5

(a)

Acquisition cost $1,090,600

Fair value of net assets 952,000

Goodwill $138,600

Davis journal entry

Current assets 510,000

Plant and equipment 1,056,000

Patents 81,000

Goodwill 138,600

Current liabilities 276,000

Long-term debt 419,000

 Cash 1,090,600

Professional fees expense 21,000

Cash 21,000

(b)

Davis is clearly the acquirer because its shareholder group holds the largest block of shares.

(i) The goodwill calculation is the same as in (a) above because 133,000 shares @ $8.20 per
share equals $1,090,600.
Current assets 510,000
Plant and equipment 1,056,000
Patents 81,000
Goodwill 138,600
Current liabilities 276,000
Long-term debt 419,000
Ordinary shares (133,000 shares x $8.2) 1,090,600

Ordinary shares 6,800

Cash 6,800

Professional fees expense 21,000

Cash 21,000

(ii)
Bagley Incorporated
Statement of Financial Position
August 1, Year 4

Investment in Davis Inc. $1,090,600

Ordinary shares $185,000

Retained earnings (517,000 + 388,600*) 905,600
$1,090,600
*Gain on sale (1,090,600 – [1,371,000 – 393,000 – 276,000] = 388,600)

Problem 3-8
(a)
Company X is clearly the acquirer of Company Y and Company Z.

Company Y

Acquisition cost (13,500 shares  $15) $202,500

(a)

Fair value of net assets 170,000

Goodwill $32,500
(b)

Company Z

Acquisition cost (12,000 shares  $15) $180,000

(c)

Fair value of net assets 103,000

Goodwill $77,000
(d)

Total goodwill
Company Y above (b) $32,500

Company Z above (d) 77,000

$109,500
(e)

Direct costs associated with acquisition:

Cost of issuing shares $12,000

(f)

Professional fees 30,000

(g)

Total $42,000
(h)

Company X
Pro Forma Statement of Financial Position
January 2, Year 4

Assets (400,000 – (h) 42,000 + 350,000 + 265,000) $973,000

Goodwill (e) 109,500
$1,082,500

Ordinary shares (75,000 – (f) 12,000 + (a) 202,500 + (c) 180,000) $445,500
Retained earnings (92,500 – (g) 30,000) 62,500
Liabilities (232,500 + 180,000 + 162,000) 574,500
$1,082,500

(b) Pro forma Statements of Financial Position

January 2, Year 4
Company Y Company Z
Investment in shares of Company X $202,500 $180,000

Ordinary shares 48,000 60,000

Retained earnings** 154,500 120,000
$ 202,500 $180,000
**Retained earnings before sale $70,000 $35,000
Gain on sale of net assets 84,500 85,000
$154,500 $120,000
(Company Y: $202,500 – $118,000 = $84,500)
(Company Z: $180,000 – $95,000 = $85,000)

Problem 3-11

(a)

(i)

Investment in Sax 976,000

Professional fees expense 14,000

(a)

Cash 990,000
(b)

(ii)

Acquisition cost $976,000

(c)

Fair value of assets $1,560,000

Fair value of liabilities -668,000 892,000

Goodwill $ 84,000
(d)

Note that under IFRS 3, an assembled workforce is not considered an identifiable asset (par.
B37). As such, it cannot be recognized apart from goodwill. On this basis, the $116,000 value
that management believed the assembled workforce to be worth would be recognized as part of
goodwill and NOT as a separate intangible asset. This is supported by the criteria for separate
recognition of an intangible asset apart from goodwill as outlined in IFRS 3 requiring that the
asset either meet the contractual-legal criterion or the separability criterion. That is:

(a) the asset results from contractual or other legal rights (regardless of whether those
rights are transferable or separable from the acquired enterprise or from other rights and
obligations); or
(b) the asset is capable of being separated or divided from the acquired enterprise and
sold, transferred, licensed, rented, or exchanged (regardless of whether there is intent to
do so).
Otherwise, it should be included in the amount recognized as goodwill.

Neither of the above criteria is met in the case of the assembled workforce.

Red Corp

Consolidated Balance Sheet

August 1, Year 3

Current assets (1,760,000 – (b) 990,000 + 484,000) $1,254,000

Plant and equipment (1,272,000 + 988,000) 2,260,000

Patents (0 + 88,000) 88,000

Goodwill (d) 84,000

$3,686,000

Current liabilities (1,520,000 + 268,000) $1,788,000

Long-term debt (496,000 + 400,000) 896,000

Common shares 880,000

Retained earnings (136,000 – (a) 14,000) 122,000

$3,686,000

(b)

(i)
Investment in Sax 976,000
Common shares (c) 976,000
(e)
Professional fees expense 14,000
(f)
Common shares 9,000
(g)
Cash 23,000
(h)

(ii)
Goodwill calculation is the same as part (a) because the acquisition cost is 122,000 shares @
$8 per share equals $976,000

Red Corp.
Consolidated Balance Sheet
August 1, Year 3

Current assets (1,760,000 + 484,000 – (h) 23,000) $2,221,000

Plant and equipment (1,272,000 + 988,000) 2,260,000
Patents 88,000
Goodwill (d) 84,000
$4,653,000
Current liabilities (1,520,000 + 268,000) $1,788,000
Long-term debt (496,000 + 400,000) 896,000
Common shares (880,000 + (e) 976,000 – (g) 9,000) 1,847,000
Retained earnings (136,000 – (f) 14,000) 122,000
$4,653,000

(c)
(i)
Investment in Sax 976,000
(i)
Common shares (c) 976,000
(j)
Professional fees expense 14,000
(k)
Common shares 9,000
(l)
Cash 23,000
(m)

(ii)
Red Corp.
Balance Sheet
August 1, Year 3

Current assets (1,760,000 – (m) 23,000) $1,737,000

Plant and equipment (net) 1,272,000
Investment in Sax (i) 976,000
$3,985,000

Current liabilities $1,520,000

Long-term debt 496,000
Common shares (880,000 + (j) 976,000 – (l) 9,000) 1,847,000
Retained earnings (136,000 – (k) 14,000) 122,000
$3,985,000