CHAPTER 1 UNDERSTANDING THE ISSUES 1. (a) horizontal combination—both are marine engine manufacturers (b) vertical combination—manufacturer buys distribution outlets (c) conglomerate—unrelated businesses 2. By accepting cash in exchange for the net assets of the company, the seller would have to recognize an immediate taxable gain. However, if the seller were to accept common stock of another corporation instead, the seller could construct the transaction as a tax-free reorganization. The seller could then account for the transaction as a tax-free exchange. The seller would not pay taxes until the shares received were sold. 3. Identifiable assets (fair value)......... $600,000 Deferred tax liability ($200,000 × 40%)...................... (80,000) Net assets....................................... $520,000 Goodwill [($850,000 – $520,000) ÷ 60%] . $550,000 Deferred tax liability ($550,000 × 40%)...................... (220,000) Net goodwill .................................... $330,000 4. (a) The net assets and goodwill will be recorded at their full fair value on the books of the parent on the date of acquisition. (b) The net assets will be “marked up” to fair value and goodwill will be recorded at the end of the fiscal year when the consolidated financial statements are prepared through the use of a consolidated worksheet. 5. Puncho will record the net assets at their fair value of $800,000 on its books. Also, Puncho will record goodwill of $100,000 ($900,000 – $800,000) resulting from the excess of the price paid over the fair value. Semos will record the removal of its net assets at their book values. Semos will record a gain on the sale of business of $500,000 ($900,000 – $400,000). 6. Zone Group Cumulative Analysis Total Total Priority $ 20,000 $ 20,000 Nonpriority 500,000 520,000 (a) This price exceeds the fair value of all accounts and allows for goodwill. Current assets (fair value) .............. $120,000 Land (fair value).............................. 80,000 Liabilities (fair value)....................... (100,000) Building & equipment (fair value).... 400,000 Customer list (fair value)................. 20,000 Goodwill .......................................... 280,000 Extraordinary gain........................... — $800,000 (b) This price is a bargain. The nonpriority accounts are discounted. There is $430,000 ($450,000 – $20,000 to priority accounts) available to be allocated to these accounts. Current assets (fair value) .............. $120,000 Liabilities (fair value)....................... (100,000) Land [(80 ÷ 500) × $430,000] ......... 68,800 Building & equipment [(400 ÷ 500) × $430,000] ........... 344,000 Customer list [(20 ÷ 500) × $430,000] 17,200 Goodwill .......................................... — Extraordinary gain........................... — Total ........................................... $450,000 (c) This price creates an extraordinary gain. Only priority accounts are recorded. Current assets (fair value) .............. $120,000 Liabilities (fair value)....................... (100,000) Building & equipment (no amount available) ................ — Customer list (no amount available) ................ — Goodwill .......................................... — Extraordinary gain........................... (5,000) Total ........................................... $ 15,000 7. (a) Direct cost—Included with the price paid to assign values to net assets, and possibly to g