Question

On December 31, Year 7, Pepper Company, a public company, agreed to a business combination with Salt Limited, an unrelated private company. Pepper issued 72 of its common shares for all (50) of the outstanding common shares of Salt. This transaction increased the number of outstanding Pepper shares from 100 to 172. Pepper’s shares were trading at around $10 per share in days leading up to the business combination. The condensed balance sheets for the two companies on this date were as follows:
On January 1, Year 8, Pepper sold 40% of its investment in Salt to an unrelated third party for $450 in cash. The CFO at Pepper stated that Salt must have been worth $1,125 if the unrelated third party was willing to pay $450 for a 40% interest in Salt. If so, Pepper saved $405 by buying Salt for only $720. Accordingly, the CFO wants to recognize a gain of $405 in the Year 7 income statement to reflect the true value of the Salt shares.
You have been asked by the CFO to prepare a presentation to senior management on the accounting implications for the business combination and subsequent sale of 40% of the investment. She would like you to consider two alternative methods of valuing Salt on the consolidated balance at the date of acquisition—one based on cost of purchase and one based on the implied value of the subsidiary based on the sales price on January 1, Year 8.
Required:
Prepare this presentation, answering the following questions:
(a) How would Pepper’s consolidated balance sheet differ at the date of acquisition under the two different valuation alternatives? Which method best reflects economic reality? Which method is required by GAAP?
(b) How would Pepper’s consolidated balance sheet look after the sale of the 40% interest in Salt to the unrelated third party under the two alternatives?


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  • CreatedJune 08, 2015
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