Comprehensive Illustration (Estimated Time: 45 to 65 Minutes) Following are the account balances of Miller Company and Richmond Company as of December 31. The fair values of Richmond Companys assets and liabilities are also listed. Problem Miller Company Book Values 12/31 Richmond Company Book Values 12/31 Richmond Company Fair Values 12/31 Cash $ 600,000 $ 200,000 $ 200,000 Receivables 900,000 300,000 290,000 Inventory 1,100,000 600,000 820,000 Buildings and equipment (net) 9,000,000 800,000 900,000 Unpatented technology 0 0 500,000 In-process research and development 0 0 100,000 Accounts payable (400,000) (200,000) (200,000) Notes payable (3,400,000) (1,100,000) (1,100,000) Totals $ 7,800,000 $ 600,000 $ 1,510,000 Common stock$20 par value $ (2,000,000) Common stock$5 par value $ (220,000) Additional paid-in capital (900,000) (100,000) Retained earnings, 1/1 (2,300,000) (130,000) Revenues (6,000,000) (900,000) Expenses 3,400,000 750,000 Totals $ (7,800,000) $ (600,000) Note: Parentheses indicate a credit balance. Additional Information (not reflected in the preceding figures) On December 31, Miller issues 50,000 shares of its $20 par value common stock for all of the outstanding shares of Richmond Company. As part of the acquisition agreement, Miller agrees to pay the former owners of Richmond $250,000 if certain profit projections are realized over the next three years. Miller calculates the acquisition-date fair value of this contingency at $100,000. In creating this combination, Miller pays $10,000 in stock issue costs and $20,000 in accounting and legal fees. Required Millers stock has a fair value of $32 per share. Using the acquisition method: Prepare the necessary journal entries if Miller dissolves Richmond so it is no longer a separate legal entity. Assume instead that Richmond will retain separate legal incorporation and maintain its own accounting systems. Prepare a worksheet to consolidate the accounts of the two companies. If Millers stock has a fair value of $26 per share, describe how the consolidated balances would differ from the results in requirement (a). Page 65 Solution In a business combination, the accountant first determines the total fair value of the consideration transferred. Because Millers stock is valued at $32 per share, the 50,000 issued shares are worth $1,600,000 in total. Included in the consideration transferred is the $100,000 acquisition-date fair value of the contingent performance obligation. This $1,700,000 total fair value is compared to the $1,510,000 fair value of Richmonds assets and liabilities (including the fair value of IPR&D). Miller recognizes the $190,000 excess fair value ($1,700,000 $1,510,000) as goodwill. Because dissolution occurs, Miller records on its books the individual fair values of Richmonds identifiable assets and liabilities with the excess recorded as goodwill. The $10,000 stock issue cost reduces Additional Paid-In Capital. The $20,000 direct combination costs (accounting and legal fees) are expensed when incurred. Miller Companys Financial RecordsDecember 31 Cash 200,000 Receivables 290,000 Inventory 820,000 Buildings and Equipment 900,000 Unpatented Technology 500,000 Research and Development Asset 100,000 Goodwill 190,000 Accounts Payable 200,000 Notes Payable 1,100,000 Contingent Performance Obligation 100,000 Common Stock (Miller) (par value) 1,000,000 Additional Paid-In Capital (fair value in excess of par value) 600,000 To record acquisition of Richmond Company Professional Services Expense 20,000 Cash (paid for combination costs) 20,000 To record legal and accounting fees related to the combination. Additional Paid-In Capital 10,000 Cash (stock issuance costs) 10,000 To record payment of stock issuance costs. Under this scenario, the acquisition fair value is equal to that computed in part (a1). 50,000 shares of stock at $32.00 each $1,600,000 Contingent performance obligation 100,000 Acquisition-date fair value of consideration transferred $1,700,000 Because the subsidiary is maintaining separate incorporation, Miller establishes an investment account to reflect the $1,700,000 acquisition consideration: Millers Financial RecordsDecember 31 Investment in Richmond Company 1,700,000 Contingent Performance Obligation 100,000 Common Stock (Miller) (par value) 1,000,000 Additional Paid-In Capital (fair value in excess of par value) 600,000 To record investment in Richmond Company. Professional Services Expense 20,000 Cash (paid for combination costs) 20,000 To record legal and accounting fees related to the combination. Additional Paid-In Capital 10,000 Cash (stock issuance costs) 10,000 To record payment of stock issuance costs. Page 66 Because Richmond maintains separate incorporation and its own accounting system, Miller prepares a worksheet for consolidation. To prepare the worksheet, Miller first allocates Richmonds fair value to assets acquired and liabilities assumed based on their individual fair values: Fair value of consideration transferred by Miller $1,700,000 Book value of Richmond 600,000 Excess fair value over book value $1,100,000 Allocations are made to specific accounts based on differences in fair values and book values: Receivables ($290,000 $300,000) $(10,000) Inventory ($820,000 $600,000) 220,000 Buildings and equipment ($900,000 $800,000) 100,000 Unpatented technology ($500,000 0) 500,000 In-process research and development 100,000 910,000 Goodwill $190,000 The following steps produce the consolidated financial statements total in Exhibit 2.8: Exhibit 2.8 Comprehensive IllustrationSolutionAcquisition Method MILLER COMPANY AND RICHMOND COMPANY Consolidation Worksheet For Period Ending December 31 Consolidation Entries Consolidated Totals Accounts Miller Company Richmond Company Debit Credit Income Statement Revenues (6,000,000) (6,000,000) Expenses 3,420,000* 3,420,000* Net income (2,580,000) (2,580,000) Statement of Retained Earnings Retained earnings, 1/1 (2,300,000) (2,300,000) Net income (above) (2,580,000) (2,580,000) Retained earnings, 12/31 (4,880,000) (4,880,000) Balance Sheet Cash 570,000* 200,000 770,000 Receivables 900,000 300,000 (A)10,000 1,190,000 Inventory 1,100,000 600,000 (A) 220,000 1,920,000 Investment in Richmond Company 1,700,000* 0 (A) 1,100,000 0 (S)600,000 Buildings and equipment (net) 9,000,000 800,000 (A) 100,000 9,900,000 Goodwill 0 0 (A) 190,000 190,000 Unpatented technology 0 0 (A) 500,000 500,000 Research and development asset 0 0 (A) 100,000 100,000 Total assets 13,270,000 1,900,000 14,570,000 Accounts payable (400,000) (200,000) (600,000) Notes payable (3,400,000) (1,100,000) (4,500,000) Contingent performance obligation (100,000)* 0 (100,000) Common stock (3,000,000)* (220,000) (S) 220,000 (3,000,000) Additional paid-in capital (1,490,000)* (100,000) (S) 100,000 (1,490,000) Retained earnings, 12/31 (above) (4,880,000)* (280,000) (S) 280,000 (4,880,000) Total liabilities and equities (13,270,000) (1,900,000) 1,710,000 1,710,000 (14,570,000) Note: Parentheses indicate a credit balance. *Balances have been adjusted for issuance of stock, payment of combination expenses, and recognition of contingent performance obligation. Beginning retained earnings plus revenues minus expenses. Page 67Millers balances have been updated on this worksheet to include the effects of both the newly issued shares of stock, the recognition of the contingent performance liability, and the combination expenses. Richmonds revenue and expense accounts have been closed to Retained Earnings. The acquisition method consolidates only postacquisition revenues and expenses. Worksheet Entry S eliminates the $600,000 book value component of the Investment in Richmond Company account along with the subsidiarys stockholders equity accounts. Entry A adjusts all of Richmonds assets and liabilities to fair value based on the allocations determined earlier. If the fair value of Millers stock is $26.00 per share, then the fair value of the consideration transferred in the Richmond acquisition is recomputed as follows: Fair value of shares issued ($26 50,000 shares) $1,300,000 Fair value of contingent consideration 100,000 Total consideration transferred at fair value $1,400,000 Because the consideration transferred is $110,000 less than the $1,510,000 fair value of the net assets received in the acquisition, a bargain purchase has occurred. In this situation, Miller continues to recognize each of the separately identified assets acquired and liabilities assumed at their fair values. Resulting differences in the consolidated balances relative to the requirement (a) solution are as follows: The $110,000 excess fair value recognized over the consideration transferred is recognized as a gain on bargain purchase. Consolidated net income increases by the $110,000 gain to $2,690,000. No goodwill is recognized. Millers additional paid-in capital decreases by $300,000 to $1,190,000. Consolidated retained earnings increase by the $110,000 gain to $4,990,000. Also, because of the bargain purchase, the Investment in Richmond Company account balance on Millers separate financial statements shows the $1,510,000 fair value of the net identified assets received. This valuation measure is an exception to the general rule of using the consideration transferred to provide the valuation basis for the acquired firm.

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