Advanced Financial Accounting 12th Edition by Theodore Christensen solution manual

 
b. The FASB has not dealt with leveraged buyouts in either current pronouncements or exposure drafts of proposed standards. The Emerging Issues Task Force has addressed limited aspects of accounting for LBOs. In EITF 84-23, “Leveraged Buyout Holding Company Debt,” the Task Force did not reach a consensus. In EITF 88-16, “Basis in Leveraged Buyout Transactions,” the Task Force did provide guidance as to the proper basis that should be recognized for an acquiring company’s interest in a target company acquired through a leveraged buyout.
 
c. Whether an LBO is a type of business combination is not clear and probably depends on the structure of the buyout. The FASB has not taken a position on whether an LBO is a type of business combination. The EITF indicated that LBOs of the type it was considering are similar to business combinations. Most LBOs are effected by establishing a holding company for the purpose of acquiring the assets or stock of the target company. Such a holding company has no substantive operations. Some would argue that a business combination can occur only if the acquiring company has substantive operations. However, neither the FASB nor EITF has established such a requirement. Thus, the question of whether an LBO is a business combination is unresolved.
 
d. The primary issue in deciding the proper basis for an interest in a company acquired in an LBO, as determined by EITF 88-16, is whether the transaction has resulted in a change in control of the target company (a new controlling shareholder group has been established). If a change in control has not occurred, the transaction is treated as a recapitalization or restructuring, and a change in basis is not appropriate (the previous basis carries over). If a change in control has occurred, a new basis of accounting may be appropriate.
 
 

SOLUTIONS TO EXERCISES
 
E1-1  Multiple-Choice Questions on Complex Organizations
 
1. b – As companies grow in size and respond to their unique business environment, they often develop complex organizational and ownership structures.
 
(a) Incorrect. The need to avoid legal liability is not a direct result of increased complexity.
(c) Incorrect. Part of the reason the business environment is complex is due to the increased number and type of divisions and product lines in companies.
(d) Incorrect. This statement is false. There has been an impact on organizational structure and management.
 
2. d – A transfer of product to a subsidiary does not constitute a sale for income purposes and as such would not increase profit for the parent.
 
(a) Incorrect. Shifting risk is a common reason for establishing a subsidiary.
(b) Incorrect. Corporations often establish subsidiaries in other regulatory environments so that the parent company is not explicitly affected by the regulatory control.
(c) Incorrect. Corporations will often establish subsidiaries to take advantage of tax benefits that exist in different regions.
 
3. a – When a merger occurs, all the assets and liabilities are transferred to the purchasing company and any excess of the purchase price over the fair value of the net assets is recorded as goodwill on the purchaser’s books.
 
(b) Incorrect. This combination results in a parent-subsidiary relationship in which an investment in Penn would be recorded.  In the event that goodwill were present in this transaction, it would be reported on the consolidated books and not Randolph’s books.
(c) Incorrect. In a spin-off, no change to net assets occurs, and consequently no goodwill is recorded.
(d) Incorrect. In a split-off, no change to net assets occurs, and consequently no goodwill is recorded.
 
4. b – In an internal expansion in which the existing company creates a new subsidiary, the assets and liabilities are recorded at the carrying values of the original company.
 
(a) Incorrect. This is not in accordance with GAAP; assets are transferred at the parent’s book (carrying) value.
(c) Incorrect. Not in accordance with US GAAP; no gain or loss is permitted because the assets are transferred at the parent’s book value.
(d) Incorrect. Not in accordance with US GAAP – Goodwill is not created when a company creates a subsidiary through internal expansion.
 
5. d – This is the proper impairment test required under US GAAP, according to FASB 142/ASC 350.
 
(a) Incorrect. This is not the proper test for impairment under US GAAP.
(b) Incorrect. This is not the proper test for impairment under US GAAP.
(c) Incorrect. This is not the proper test for impairment under US GAAP.
 
 

 
E1-2  Multiple-Choice Questions on Recording Business Combinations