Illustration of the Difference Between the Purchase Method and the Pooling of Interests Method On October 31,19x8, Idol Steel Corporation issued 18,000 shares of its $1 par (current fair value of $10 per share) common stock for all the outstanding common stock of Crown Welding Company in a statutory merger. Out-of-pocket costs of the business combination paid by Idol on October 31, 19x8 follow: Direct costs of the business combination....................$22,000 Cost of registering and issuing common stock................ 15,000 Total out-of-pocket costs of business combination.......$37,000 Crown Welding's balance sheet on October 31, 19x8: Crown Welding Company Balance Sheet October 31,19x8 Fair Assets Value Inventories................................ $ 96,000 $110,000 Other current assets....................... 52,000 52,000 Plant assets (net)......................... 172,000 195,000 Total assets........................ $320,000 $357,000 Liabilities & Stockholders' Equity Liabilities................................ $175,000 $175,000 Common Stock, $5 par....................... 20,000 Additional paid-in capital................. 50,000 Retained earnings.......................... 75,000 Total liab. & Stockholders' equity.... $320,000 The journal entries to record the combination on the books of Idol Steel assuming the purchase method must be applied are: October 31,19x8 Investment in Crown Welding 180,000 Common stock 18,000 Additional paid-in capital 162,000 To record issuance of 18,000 shares of $1 par common stock with a fair value of $10 per share in a purchase merger-type business combination with Crown Welding. October 31, 19x8 Investment in Crown Welding 22,000 Additional paid-in capital 15,000 Cash 37,000 To record additional direct costs of combining with Crown Welding; $22,000 for costs incurred to initiate and consummate the combination and $15,000 for costs of registering and issuing the securities. October 31, 19x8 Inventories 110,000 Other current assets 52,000 Plant 195,000 Goodwill 20,000 Liabilities 175,000 Investment in Crown Welding 202,000 To record the assets and liabilities received in a purchase merger with Crown Welding. Note that the amount of the goodwill is computed as follows: Goodwill = Cost - Fair market value of the ownership interest acquired in Crown's identifiable net assets. = (180,000 + 22,000) - (110,000 +52,000 +195,000 - 175,000) = 202,000 - 182,000 = 20,000 Now instead of the purchase method, assume that the pooling of interests method is appropriate. The journal entries to record the combination on Idol Steel's books are: October 31, 19x8 Investment in Crown Welding 145,000 Common Stock -- Idol Steel 18,000 Additional paid-in capital 52,000 Retained Earnings (from Crown Welding) 75,000 To record issuance of 18,000 shares of $1 par common stock in a pooling of interests, merger-type business combination with Crown Welding. Expenses of business combination 37,000 Cash 37,000 To record expenses incurred in exchanging stock with Crown Welding. Inventories 96,000 Other current assets 52,000 Plant 172,000 Liabilities 175,000 Investment in Crown Welding 145,000 To record the assets and liabilities received in a pooling of interests merger with Crown Welding. The increase to additional paid-in capital can be verified as follows: Paid-in capital of Crown Welding prior to the combination (20,000 + 50,000) $70,000 Stock issued for the combination 18,000 Amount of additional paid-in capital (Idol Steel) $52,000 Financial Statement Analysis PURCHASE METHOD Balance Sheet After Prior to Combination Combination Idol Steel Crown Welding Debit Credit Idol Steel ASSETS Cash 100,000 - 37,000 63,000 Inventories 200,000 96,000 110,000 310,000 Investment - - 180,000 202,000 - 22,000 Other current assets 156,000 52,000 52,000 208,000 Plant(net) 260,000 172,000 195,000 455,000 Goodwill - - 20,000 20,000 -------- -------- -------- -------- ---------- Total Assets $716,000 $320,000 $579,000 $239,000 $1,056,000 LIABILITIES & SH'S EQUITY Liabilities 266,000 175,000 175,000 441,000 Common Stock 50,000 20,000 18,000 68,000 APIC 200,000 50,000 15,000 162,000 347,000 R/E 200,000 75,000 200,000 -------- -------- -------- -------- ---------- Total Liab. & SH's Equity $716,000 $320,000 $15,000 $355,000 $1,056,000 Consolidated Income Statement Idol Steel Corporation (after combination) Revenue $1,678,000 COGS 892,000 ----------- Gross Margin 786,000 Operating Expenses 81,000 ----------- Net Income $705,000 Note: 1- In the Purchase Method the assets and liabilities of Crown Welding are transferred to Idol Steel at their fair market value (e.g. Plant is transferred at FMV of $195,000, rather than cost of $172,000). 2- The direct costs of the business combination are considered part of the investment cost while the cost of registering and issuing common stock is charged to APIC. 3- Crown Welding's retained earnings is not carried forward to Idol Steel. 4- Goodwill is recorded in the purchase method for the excess of investment cost over the FMV of Crown Welding's net identifiable assets. 5- The Consolidated Income Statement is not affected by the expenses related to the combination. POOLING OF INTERESTS Balance Sheet After Prior to Combination Combination Idol Steel Crown Welding Debit Credit Idol Steel ASSETS Cash 100,000 - 37,000 63,000 Inventories 200,000 96,000 96,000 296,000 Investment - - 145,000 145,000 - Other current assets 156,000 52,000 52,000 208,000 Plant(net) 260,000 172,000 172,000 432,000 -------- -------- -------- -------- --------- Total Assets $716,000 $320,000 $365,000 $182,000 $999,000 LIABILITIES & SH'S EQUITY Liabilities 266,000 175,000 175,000 441,000 Common Stock 50,000 20,000 18,000 68,000 APIC 200,000 50,000 52,000 252,000 R/E 200,000 75,000 37,000 75,000 238,000 -------- -------- -------- -------- -------- Total Liab. & SH's Equity $716,000 $320,000 $37,000 $320,000 $999,000 Consolidated Income Statement Idol Steel Corporation (after combination) Revenue $1,678,000 COGS 892,000 ---------- Gross Margin 786,000 Operating Expenses 81,000 Expenses of Business Combination 37,000 ---------- Net Income $668,000 Note: 1- In the pooling of interests method the assets and liabilities of Crown Welding are transferred to Idol Steel at their carrying(book) value. 2- The Consolidated Income Statement reflects 'Expenses of Business Combination' of $37,000. 3- Retained earnings is reduced on Idol's balance sheet to account for the combination expenses. 4- Crown Welding's retained earnings is carried forward to Idol Steel. 5- No goodwill is recorded in the pooling of interests method.