Question

In January 2005, Pinch Corporation, a chain of discount stores, began a program of business combinations with its principal suppliers. On May 31, 2005, the close of its fiscal year, Pinch paid $8,500,000 cash and issued 100,000 shares of its common stock (current fair value $20 a share) for all 10,000 outstanding shares of common stock of Silver Company. Silver was a furniture manufacturer whose products were sold in Pinch’s stores. Total n stockholders’ equity of Silver on May 31, 2005, was $9,000,000. Out-of-pocket costs attributable to the business combination itself (as opposed to the SEC registration statement for the 100,000 shares of Pinch’s common stock) paid by Pinch on May 31, 2005, totaled $100,000.In the consolidated balance sheet of Pinch Corporation and subsidiary on May 31,2005, the $1,600,000 [$8,500,000 + (100,000 x $20) + $100,000 – $9,000,000] difference between the parent company’s cost and the carrying amounts of the subsidiary’s identifiable net assets was allocated in accordance with purchase accounting as follows: Inventories $ 250,000Plant assets 850,000Patents 300,000Goodwill 200,000Total excess of cost over carrying amounts of subsidiary’s net assets $1,600,000 Under terms of the indenture for a $1,000,000 bond liability of Silver, Pinch was obligated to maintain Silver as a separate corporation and to issue a separate balance sheet for Silver each May 31. Pinch’s controller contends that Silver’s balance sheet on May 31, 2005, should value net assets at $10,600,000 – their cost to Pinch. Silver’s controller disputes this valuation, claiming that generally accepted accounting principles require issuance of a historical cost balance sheet for Silver on May 31, 2005. Instructionsa. Present arguments supporting the Pinch controller’s position.b. Present arguments supporting the Silver controller’s position.c. Which position do you prefer? Explain.

Answer 1

a. Arguments supporting the Pinch controller’s position:

The Pinch Corporation has acquired Silver Company for $8,500,000 in cash and 100,000 shares of its common stock, which have a fair value of $20 per share. Additionally, the out-of-pocket costs attributable to the business combination were $100,000. The total net assets of Silver Company on May 31, 2005, were $9,000,000. Therefore, the total cost of the acquisition was $10,600,000 ($8,500,000 + $2,000,000 + $100,000 - $9,000,000).

Under purchase accounting, the excess of cost over the carrying amounts of the identifiable net assets of the subsidiary must be allocated among the assets acquired. In this case, the excess cost was $1,600,000, which was allocated to the inventories, plant assets, patents, and goodwill of Silver Company.

Since Pinch Corporation now owns 100% of Silver Company, it has the right to value the net assets at their fair value, which is $10,600,000. Therefore, the Pinch controller's position is that the net assets of Silver Company on May 31, 2005, should be valued at their cost to Pinch, which is $10,600,000.

b. Arguments supporting the Silver controller’s position:

The Silver controller argues that generally accepted accounting principles (GAAP) require the issuance of a historical cost balance sheet for Silver on May 31, 2005. According to GAAP, when a business combination takes place, the acquired company's net assets should be recorded at their historical cost. The historical cost of Silver Company's net assets on May 31, 2005, was $9,000,000, which should be reflected on the balance sheet.

c. Preferred position and explanation:

I prefer the Pinch controller's position. When a company acquires another company, the acquiring company has the right to value the net assets of the acquired company at their fair value. Pinch Corporation paid $10,600,000 to acquire Silver Company, and therefore, it has the right to value the net assets of Silver Company at that amount. The excess of cost over carrying amounts should be allocated among the assets acquired, which is consistent with the principles of purchase accounting. Therefore, the consolidated balance sheet of Pinch Corporation and subsidiary on May 31, 2005, should value the net assets of Silver Company at $10,600,000.

Step-by-step explanation:

follow me!