Comparison of Earnings Effects of Purchase (Old and New Rules) versus Pooling of Interests The Arthur Company is considering a merger with the Guinevere Corporation as of January 1, 2004. It has not been determined whether the transaction will meet the criteria for a pooling of interests. It has been determined, however, that the deal will be structured so as to qualify as a nontaxable exchange for tax purposes. If the deal goes through, the Arthur Company expects to issue 20,000 shares of its $5 par stock; the stock is currently trading at $22.25 per share.
The balance sheet of the Guinevere Corporation at the acquisition date is projected to appear as shown on page 66. Also shown are Arthur’s assessments of Guinevere’s market values at January 1, 2004. LO4 Guinevere Guinevere Book Values Market Values Current Assets:
Cash $20,000 $20,000 Accounts Receivable 15,000 15,000 Inventory 30,000 30,000 Property, Plant, and Equipment:
Building (net) $100,000 $250,000 Equipment (net) 60,000 120,000 Total Assets $225,000 Total Liabilities $30,000 $30,000 Common Stock, $10 par value 80,000 Retained Earnings 115,000 Total Liabilities and Equities $225,000 Because Arthur Company’s management is worried about the relative effects of purchase and pooling on future income statements, they have asked you to compare income before taxes for the year 2004 under purchase versus pooling of interests accounting.
Combined revenues for Arthur and Guinevere are estimated at $300,000 for 2004. Estimated expenses are $120,000, not including depreciation on Guinevere’s property and equipment or any goodwill amortization related to the acquisition of Guinevere. Assume that the building has a remaining useful life of 20 years, and the equipment has a life of 10 years. Assume that any goodwill was to be amortized over a 40-year period under old purchase rules (not at all under new purchase rules), and straight-line depreciation and amortization are used.
Required:
Compare income before taxes for the year 2004 under the purchase method—old rules, the purchase method—new rules, and the pooling of interests method. Show support for your calculations.