Acquisition of Cats Rule: On January 1, 2019, Buddy Dog Food Company acquired Cats Rule Food Company for $3,000,000 cash and 2,500,000 shares of Buddy, $5 par common stock which had a fair value of $12 per share on 1/1/19. These amounts were paid to acquire all of the shares of Cats Rule Food Company. Buddy immediately delisted those shares and decided to treat the acquisition as a merger.

Buddy also has agreed to pay the stockholders additional compensation based upon the realized Cats Rule EBITDA over the first 3 years that Buddy owns Cats Rule. The compensation will be 10% of the excess of the 3-year cumulative EBITDA over $2,000,000. A discount rate of 10% is reasonable. The probability distribution that Buddy has estimated for Cats Rule’s cumulative EBITDA is:

3 year Cumulative EBITDA	Probability
$1,000,000	.3
$2,100,000	.2
$3,000,000	.4
$5,000,000	.1

Other information about the acquisition: The 1/1/19 Buddy’s balance sheet before the acquisition is recorded and Cats Rule balance sheet and related booked asset and liability fair values are below:

	Buddy - Book Values
Cash	$7,000,000
Inventory	1,000,000
Plant & Equipment	20,000,000
Trademarks
Goodwill	8,000,000
Total Assets	36,000,000
Current Liabilities	500,000
Bonds Payable	10,000,000
Common Stock	5,000,000
Additional Paid In Capital	14,000,000
Retained Earnings	6,500,000
	36,000,000

As the Buddy accountant in charge of accounting for the acquisition, you discover the following:

- In-process Research and Development’s fair value is $700,000

- The estimated decrease in cost due to duplicate distribution processes is $500,000 to be realized in the first two years of the combined company.

- Customer contracts and relationships are valued at $1,000,000Cats Rule has an office lease that is below market rate, it is estimated to be valued at $30,000 and Buddy will continue to use the space.

- On 1/1/19, Cats Rule’s bond payable has a $8,000,000 face. It pays 6% annually and has 10 years left until it matures. At 1/1/19, such bonds sell to yield 2%.

Required:

a. Compute the bond’s fair value at 1/1/19. Show all of your work.

b. Show in detail how your computed goodwill or bargain purchase gain as applicable. Label well all of your work.

c. Prepare the entry that Buddy will make on its books to record the acquisition of Cat’s Rule.

d. Prepare the Buddy balance sheet immediately after the acquisition has been recorded, on 1/1/19.5. Assume that you discover on 5/1/19 a lawsuit that had been filed on 12/15/18 about a product safety issue with Cats Rule chews. The estimated liability of the lawsuit is $400,000. Prepare the adjusting entry related to this discovery.

Answer rating: 100% (QA)

Consideration paid is the amount of cash or other assets exchanged in the event of one company acqui... View the full answer