U3. Financial statement Analysis

Chapter 5, Exercise 5-4, Problem 5-6

Spellman Company acquires 90% of Moore Company in a business combination. The total consideration is agreed upon, but the exact nature of Spellman’s payment is not yet fully specified. This business combination is accounted for as a purchase. It is expected that at the date of the business combination, the fair value will exceed the book value of Moore’s assets minus liabilities. Spellman desires to prepare consolidated financial statements that include the financial statements of Moore.

Required:

a. Explain how the method of accounting for business combination affects whether goodwill is reported.

b. If goodwill is recorded, explain how to determine the amount of goodwill.

c. From a conceptual standpoint, explain why consolidated financial statements should be prepared.

d. From a conceptual standpoint, identify the first necessary condition before consolidated financial statements are prepared.

Problem 5-6

Your supervisor asks you to analyze the potential purchase of Drew Company by your firm, Pierson, Inc. You are provided the following information (in million):

Pierson,Inc. Drew COMPANY

Historical Historical Fair

Cost Based Cost Based Value

Current Assets $70 $60 $65

Land 60 10 10

Buildings, net 80 40 50

Equipment, net 90 20 40

Total Assets $300 $130 $165

Current Liabilities $120 $20 $20

Shareholders’ equity 180 110 —–

Total liabilities and equity $300 $130

Required:

a. Prepare a pro forma combined balance sheet using purchase accounting. Note that Pierson pays $180 million in cash for Drew where the cash is obtained by using long term debt.

b. Discuss how differences between pooling and purchase accounting for acquisitions affect future reported earnings if the Pierson/Drew business combination.

Chapter 6, Problems 6-4

Campbell Soup Company

Required:

a. Estimate the amount of depreciation expense reported on Campbell’s tax returns for each of the years 11,10, and 9. Use tax return of 34%

b. Identify the amounts and sources in each of the years 11, 10 and 9 for the following (note: combine federal, foreign, and state taxes).

(1) Earnings before income taxes

(2) Expected income tax at 34%

(3) Total income tax expense.

(4) Total Income tax due

(5) Total income tax due and not yet paid at end of years 11,10 and 9.

c. Why does the effective tax rate for the years 11, 10 and 9 differ from 34% of income before taxes ? Answer with a reconciliation included explanations.

d. There is a small tax benefit derived from the divestiture and restructuring charges in year 10. Can you estimate the cash outlays for these charges in year 10?

Problem 6-9

Ace company’s net income for the year $4 million and the number of common shares outstanding is 3 million (there is no change in shares outstanding during the year). Ace has options and warrants outstanding to purchase 1 million common shares at $15 per share.

Required:

a. If the average market value of the common share us $20 year end price is $25, interest rate on borrowing is 6%, and the tax rate is 50%, then compute both basic and diluted EPS.

b. Do the same computations as in a assuming net income for the year is only $3 million, the average market value per common share is $18, and year end price is $20 per share.

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