Franklin Company, headquartered in the United States, acquired 100 percent of the outstanding shares of Jefferson, Inc. by issuing 1 million shares of its $1 par common stock ($15 market value).

Question

Franklin Company, headquartered in the United States, acquired 100 percent of the outstanding shares of Jefferson, Inc. by issuing 1 million shares of its $1 par common stock ($15 market value). Immediately before the transaction, the two companies compiled the following information:

Show the balances in the post-combination balance sheet using

1. The pooling of interests method.
2. The purchase method.

Show the balances in the post-combination balance sheet using

1. The pooling of interests method.
2. The purchase method.

Accepted Answer

Solution to 1: Pooling-of-Interest Method
If the Franklin and Jefferson combination were accounted for as a statutory merger using the pooling of interests method, the post combination balance sheet of the combined entity would appear as follows:

Under the pooling of interests method, assets and liabilities are combined using book values. For example, Franklin’s $10,000 cash and receivables are added to Jefferson’s $300 cash and receivables for a combined balance of $10,300. One of the criteria to qualify for pooling of interests is that the transaction must be a stock for stock exchange.

Prior to the transaction, Franklin had 5 million shares of $1 par stock outstanding ($5 million). The combined entity reflects the Franklin capital stock issuance of $6 million ($5 million plus the additional 1 million shares of $1 par stock issued to effect the transaction). Jefferson’s paid in capital is eliminated on consolidation, being replaced by the stock issued by Franklin, and Jefferson’s retained earnings are carried forward to the post-combination balance sheet. Jefferson’s $1,100,000 of paid in capital is shown on the post-combination balance sheet as capital stock of $1 million (par value of Franklin stock issued) and $100,000 of additional paid in capital (residual amount of the total of capital stock (400,000) and of additional paid in capital (700,000) i.e., $1,100,000). Franklin’s additional paid in capital of $6 million is combined with the $100,000 for a total of $6,100,000.

Retained earnings of the target company are generally carried to combined financial statements. Franklin’s retained earnings of $14 million are combined with Jefferson’s retained earnings of $800,000 for reported retained earnings of $14,800,000.

Solution to 2: Purchase Method
If the Franklin and Jefferson combination were accounted for as a statutory merger using the purchase method, the purchase price allocation would be as follows:

Both IFRS and U.S. GAAP record the purchase price of the acquisition at the market value of stock issued, or $15 million. In this case, the purchase price exceeds the book value of Jefferson by $13,100,000. Inventory, PP&E (net), and long-term debt are adjusted to fair values. The excess of purchase price over fair values of the net assets results in goodwill recognition of $9,600,000.

The post-combination balance sheet of the combined entity would appear as follows:

Assets and liabilities are combined using book values of Franklin plus fair values for the assets and liabilities acquired from Jefferson. For example, the book value of Franklin’s inventory ($12 million) is added to the fair value of inventory acquired from Jefferson ($3 million) for a combined inventory of $15 million. Long-term debt has a book value of $16 million on Franklin’s pre-acquisition statements and Jefferson’s fair value of debt is $1,800,000. The combined long-term debt is recorded as $17,800,000.
Franklin’s post-merger financial statement reflects in stockholders’ equity the stock issued by the Franklin, the acquiring company. Franklin issues stock with a par value of $1 million in exchange for Jefferson’s paid in capital (capital stock plus additional paid in capital) of $1,100,000.

Shares issued are measured at fair value under both U.S. GAAP and IFRS.
Therefore, the purchase price is 1 million shares at market value of $15, or $15 million. Prior to the transaction, Franklin had 5,000,000 shares of $1 par stock outstanding ($5 million). The combined entity reflects the Franklin capital stock outstanding of $6 million ($5 million plus the additional 1 million shares of $1 par stock issued to effect the transaction). Franklin’s additional paid in capital of $6 million is increased by the $14 million additional paid in capital from the issuance of the 1 million shares ($15 million less par value of $1 million) for a total of $20 million. At the merger date, only the acquirer’s retained earnings are carried to the combined entity. Earnings of the target are included on the consolidated income statement and retained earnings only in post-acquisition periods.

	Franklin	Jefferson	Jefferson
	Book Value	Book Value	Book Value
	(000)	(000)	(000)
Cash and receivables	$10,000	$300	$300
Inventory	12,000	1,700	3,000
PP&E (net)	$\underline{27,000}$	$\underline{ 2,500}$	$\underline{4,500}$
	$49,000	$4,500	$7,800
Current payables	8,000	600	600
Long-term debt	$\underline{16,000}$	$\underline{2,000}$	$\underline{ 1,800}$
	24,000	2,600	2,400
Net assets	$25,000	$1,900	$5,400
Shareholders’ equity:
Capital stock ($1 par)	$5,000	$400
Additional paid-in capital	6,000	700
Retained earnings	$14,000	$800

Question 15.8: Franklin Company, headquartered in the United States, acquir...

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