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Company A acquired a 50% stake in Company T on January 1, 2003 by paying T's
shareholders $100,000 in cash. Pre-acquisition balance sheets for the two firms are
presented below:
Balance Sheet
Company A
Company T
Current assets
$400,000
$60,000
Fixed assets
600,000
100,000
Total
$1,000,000
$160,000
Current liabilities
$50,000
$ 30,000
Common stock
350,000
60,000
Retained earnings
600,000
70,000
Total
$1,000,000
$160,000
The fair values of company T assets and liabilities was same as the book value. Company A
reports under U.S. GAAP. What are the post-acquisition balance sheet values for total assets
for Company A under the equity and acquisition methods of accounting respectively?
A) $1,060,000 and $1,095,000.
B) $1,000,000 and $1,095,000.
C) $1,000,000 and $1,130,000.
Omricon Capital Associates specializes in making investments in the small cap market
sector. In some cases the firm operates as a supplier of private equity for restructurings. In
this instance, the firm views itself as having a value investment focus. In others, it acts as a
venture capital firm. Here, the investment focus is usually growth. Finally, in some cases it
simply takes passive investment positions in publicly-traded firms. The positions in
marketable securities are sometimes considered trading positions, and other times the view
is to hold for a longer period until valuation parameters are met or exceeded.
Omricon's chief compliance officer, Raymond "Buzz" Richards has recently become
concerned that the firm may not be correctly following the relevant accounting standards for
these investments. To ensure that the rules are being effectively adhered to, he is seeking
advice from the accounting firm of Merz-Brokaw and Associates on the matter. Sally Lee is
the Merz-Brokaw partner heading up the consulting team assigned to review the situation.
The size of the investments ranges from a few percent of the firm's outstanding equity, to
positions of greater than 50%. Richards says that it has always been his understanding that
the percentage of the equity held is the major determinant with respect to which accounting
method applies. Lee reminds him that the firm's intent for its investments also plays a role
in determining how they are accounted for.
Some of the firm's investments have not worked out as planned. Richards has conferred
with the firm's portfolio managers regarding securities being held by the firm that are worth
less than when they were acquired, and has presented a list of these investments to Lee. His
concern is what this implies for the accounting for these investments. Lee tells him that the
issue here is whether or not the security can be considered impaired, and that designating a
security as impaired implies that the decline in value is permanent.
Top managers at Omricon have asked Lee to help them evaluate the impact of the choice of
accounting method on the firm's profitability. Some members of the management team are
of the belief that the accounting method does not affect financial measures because these
are driven by underlying economic factors. Others believe that these measures can be
affected by the accounting method chosen.