At the beginning of year 1, P Ltd acquired S Ltd by issuing its own shares to shareholders of S Ltd who had an option of receiving either two shares from P Ltd for every one share held in S Ltd or $3 per share in cash, receivable half at the acquisition date and half in one year's time. S Ltd had 2,500 shares before business combination and 25% of its shareholders eleceted to receive cash and the remainder to receive shares. P Ltd's shares traded at $2 per share on the acquisition date. Due to doubts as to whether its share price could remain at or above the $2 level for three months, P Ltd agreed to compensate shareholders of S Ltd the value of any decrease in the share price below $2. P Ltd believed that there was a probability of one-third that its share price would fall to $1.80 in three months. Other information is as follows. 1. 2. 3 In addition to 4. 5 S Ltd reported $10,000 of share capital and additional paid-in capital and $7,000 of retained earnings as at the beginning of year 1. the best PLtd acquired S Ltd on a cumulative dividend basis. S Ltd recorded a dividend payable of $1,600 on the acquisition date. to shares issued, P Ltd paid $15,430 cash to S Ltd by two instalments: $10,430 at the beginning of year 1 and the remaining two years later, PLtd supplied to S Ltd a self-developed patent worth $1,304 on the date of acquisition. On the date of acquisition, S Ltd had an unrecorded liability arising from a lawsuit with the expected loss of $10,000. However, the lawyer estimated that there was a 20% chance of losing the case. On the date of acquisition, S Ltd had an unrecorded patent of $1,000 (fair value). P Ltd paid $15,000 for share issuance and $10,000 for consulting and brokerage services in relation to acquisition The bank interest rate was 5% and the income tax rate was 30%. 6. 7. 8 At the acquisition date, S Ltd's assets and liabilities were recorded as fair value except for the following: Land Plant (original cost $6,000) Carrying amount $ 4,000 4,000 6,000 Fair value 7,000 6,000 5,000 Inventory S Ltd sold the land during year 2 for $6,800. The undervalued plant had a further 4-year life. 90% of the overvalued inventory were sold in year 1 and the remaining amount was sold in year 2. Other expenses P Ltd's share price remained above $2 per share within the guarantee period; S Ltd has not settled the contingent liability by end of year 2; no amortization was charged on the unrecorded patent; and no impairment loss on goodwill since acquisition. Financial statements of the two firms for and at end of year 2 are as follows. P Ltd S Ltd Sales revenue $30,000 $8,000 Cost of sales (18,000) (5,500) Gross profit 12,000 2,500 Gain on sale of land 2,800 Depreciation expense (1,000) (500) (3,000) (2,000) Income tax expense (800) (200) Profit for the year 7,200 2,600 Retained earnings (year 2 opening) 12,800 8,000 20,000 10,600 Dividend (600) Retained earnings (year 2 ending) 20,000 10,000 Share capital ($1 par value for both firms) 15,000 2,500 Additional paid-in capital 10,000 Contingent liability 1.000 Deferred tax liability 500 Dividend payable 600 Other liabilities 1,500 400 Total equity and liabilities $ 48,000 $ 21,000 7,500 $ 5,000 5,000 (1,000) Land Plant Accumulated depreciation Deferred tax asset Inventory Cash Investment in S Ltd Total Assets $ 8,000 12,000 (4,000) 500 5,000 2,500 24,000 $ 48,000 3,000 9,000 $ 21,000 Required 1. Calculate P Ltd's cost of investment in S Ltd on the acquisition date (Round the discount factor to 7 decimal places and final answer to the nearest dollar amount). (8 marks) 2. Calculate the amount of goodwill involved on the acquisition date. (8 marks) 3. Prepare consolidation worksheet entries at beginning of year 1. (10 marks) 4. Prepare consolidation worksheet entries at end of year 1. (14 marks) 5. Prepare consolidation worksheet entries at end of year 2. (14 marks) 6. Prepare the consolidation worksheet for and at end of year 2. (46 marks) (Total marks = 100) 3 1. Calculate P Ltd's cost of investment in S Ltd on the acquisition date (Round the discount factor to 6 decimal places and final answer to the nearest d 4 5 6 7 8 9 10 11 12 Total acquisition cost 0 13 14 2. Calculate the amount of goodwill involved on the acquisiton date. (8 marks) 15 Acquisition cost 0 16 Book value of net assets acquired 17 Cost-book value differentials 0 18 19 FV BV Diff After-tax diff 20 Land 21 22 23 24 25 26 27 Goodwill 0 E F G H Dr. Cr. Consolidation 0 D 1 6. Prepare the consolidation worksheet for and at end of year 2. (46 marks) 2. P Ltd S Ltd 3 Sales revenue 30,000 8,000 4 Cost of sales 18,000 5,500 5 Gross profit 12,000 2,500 Gain on sale of land 0 2,800 7 Deprecition expense 1,000 500 8 Other expenses 3,000 2,000 9 Income tax expense 800 200 10 Profit for the period 7,200 2,600 11 Retained earnings (year 2 opening) 12,800 8,000 12 Dividend 0 600 13 Retained earnings (year 2 ending) 20,000 10,000 14 Share Capital 15,000 2,500 15 Additional paid-in capital 10,000 7,500 16 Total equity 45,000 20,000 17 Contingent liability 1,000 0 18 Deferred tax liability 500 0 19 Dividend payable 0 600 20 Other liabilities 1,500 400 21 Total equity and liability 48,000 21,000 22 23 Land 8,000 5,000 24 Plant 12,000 5,000 25 Accumulated depreciation -4,000 -1,000 26 Deferred tax asset 500 0 27 Inventory 5,000 3,000 28 Cash 2,500 9,000 29 Investment in S Ltd 24,000 0 30 Total assets 48000 21000 31 0 0 0 0