Case 2-1: Consolidating a Bargain Purchase

Your client, Great Value Hardware Stores, has come to you for assistance in evaluating an opportunity to purchase a controlling interest in a hardware store in a neighboring city. The store under consideration is a closely held family corporation. Owners of 60% of the shares are willing to sell you the 60% interest, 30,000 common stock shares in exchange for 7,500 of Great Value shares, which have a fair value of $40 each and a par value of $10 each.

Your client sees this as a good opportunity to enter a new market. The controller of Great Value knows, however, that all is not well with the store being considered. The store, Als Hardware, has not kept pace with the market and has been losing money. It also has a major lawsuit against it stemming from alleged faulty electrical components it supplied that caused a fire. The store is not insured for the loss. Legal counsel advises that the store will likely pay $300,000 in damages.

The following balance sheet was provided by Als Hardware as of December 31, 2015: Assets Liabilities and Equity Cash $ 180,000 Current liabilities $ 425,000 Accounts receivable 460,000 8% Mortgage payable 600,000 Inventory 730,000 Common stock ($5 par) 250,000 Land 120,000 Paid-in capital in excess of par 750,000 Building 630,000 Retained earnings (80,000) Accumulated depreciationbuilding (400,000) Equipment 135,000 Accumulated depreciationequipment (85,000) Goodwill 175,000 Total assets $1,945,000 Total liabilities and equity $1,945,000

Your analysis raises substantial concerns about the values shown. You have gathered the following information:

a.) Aging of the accounts receivable reveals a net realizable value of $350,000.

b.) The inventory has many obsolete items; the fair value is $600,000.

c.) Appraisals for long-lived assets are as follows: Land $100,000 Building 300,000 Equipment 100,000

d.)The goodwill resulted from the purchase of another hardware store that has since been consolidated into the existing location. The goodwill was attributed to customer loyalty.

e.)Liabilities are fairly stated except that there should be a provision for the estimated loss on the lawsuit. On the basis of your research, you are convinced that the statements of

Als Hardware are not representative and need major restatement. Your client is not interested in being associated with statements that are not accurate. Your client asks you to make recommendations on two concerns:

f.) Does the price asked seem to be a real bargain? Consider the fair value of the entire equity of Als Hardware; then decide if the price is reasonable for a 60% interest.

g.)If the deal were completed, what accounting methods would you recommend either on the books of Als Hardware or in the consolidation process?

Als Hardware would remain a separate legal entity with a substantial noncontrolling interest.

h.)What if Great Value Hardware Stores was less concerned about being associated with statements that were not accurate and felt strongly about closing the deal for non-financial reasons? How would you proceed?

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