Question

In: Accounting

Assume Dover Auto Inc. acquires all of the stock of Dover Financial Corporation. Just prior to...

Assume Dover Auto Inc. acquires all of the stock of Dover Financial Corporation. Just prior to the acquisition, their separate balance sheets are as follows:

Dover Auto Inc

Dover Financial Corporation

Total assets

227,339,000

51,933,000

Total Liabilities

184,562,000

40,933,000

Shareholders’ Equity

42,777,000

11,000,000

Total Liabilities and Equity

227,339,000

51,933,000

Assume Dover Financial Corporation’s assets and liabilities are reported at fair value. Dover Auto Inc. pays $11,000,000 in cash to Dover Financial Corporation’s shareholders for Dover Financial corporation’s assets and liabilities and then consolidates the assets and liabilities of Dover Financial Corporation with its own assets and liabilities.

  1. Please prepare the acquisition journal entry and the consolidated financial balance sheet
  2. If Dover Auto Inc. instead treats the transaction as an investment, accounted for by equity method, prepare the journal entry for this transaction and prepare balance sheet of Dover Auto Inc. with this equity investment.
  3. Analyze the effect that consolidation of Dover Financial Corporation has on key leverage ratios-such as debt to equity and debt to total assets. Please report Dover Auto Inc’s leverage ratios before investment in Dover Financial Corp, Dover Auto Inc plus equity method investment, and Dover Auto Inc. with consolidation of Dover Financial Corporation, separately.

Solutions

Expert Solution

Assume Dover Auto Inc. acquires all of the stock of Dover Financial Corporation. Dover Auto Inc. pays $11,000,000 in cash to Dover Financial Corporation’s shareholders.

The acquisition entry will be as follows:   

Debit Credit

Business Combination/Purchase Account 11000000 To Dover Financial Corporation Account 11000000 ( Purchase the business of dover Financial)

Total Assets Account 51933000 To Total Liabilities Account 40933000 To Business Combination/ Purchase account 11000000 ( Being assets and liabilities of dover financial are recorded)

Dover Financial Corporation Account 11000000 To cash Account 11000000 ( Payment to drover financial shareolder for acquisition)

Alternatively Single entry can be made-

Total Assets Account 51933000 To Total Liabilities Account 40933000 To Cash Account    11000000 ( Being assets and liabilities of dover financial are recorded)

Consolidated Balance sheet

Particulars Amount ($)

Assets(227339000+51933000-11000000) 268272000

Total Assest       268272000

Total liabilities( 184562000+40933000) 225495000 Shareholder equity 42777000   

Total Liabilities & Equity 268272000

Account as equity Transaction

Entry will be as follow Debit Credit

Investment in Drover Financial Equity Account 11000000

To Cash Account 11000000 (Being Investment in drover financial is recorded as per equity method)

Consolidated Balance sheet

Particulars Amount ($)

Assets(227339000-11000000) 216339000

Investment in Drover Financial Equity       11000000

Total Assest       227339000

Total liabilities( 184562000) 184562000 Shareholder equity 42777000   

Total Liabilities & Equity 227339000

  

Effect on key leverage ratio of Drover Auto Inc after consolidation:

Debt/ Equity Ratio   = 225495000/42777000 = 5.27:1

Debt/ Total asset Ratio =       225495000/268272000 = 0.84:1

-Report Dover Auto Inc’s leverage ratios before investment in Dover Financial Corp, Dover Auto Inc plus equity method investment, and Dover Auto Inc. with consolidation of Dover Financial Corporation

Before Cosolidation:

Debt/ Equity Ratio = 184,562,000/42,777,000 = 4.31: 1

Debt/ Total asset Ratio =    184,562,000/227,339,000 = 0.81: 1

After Cosolidation (Account as equity):

Debt/ Equity Ratio = 184,562,000/42,777,000 = 4.31: 1

Debt/ Total asset Ratio =    184,562,000/227,339,000 = 0.81: 1

After Cosolidation ( other than account as equity)

Debt/ Equity Ratio   = 225495000/42777000 = 5.27:1

Debt/ Total asset Ratio =       225495000/268272000 = 0.84:1

On the calculation of above, we can conclude that-

  • If We account the transaction of purchase stock by Drover Auto Inc of Drover financial as Equity then there is no effect on Ratio of Debt/equity & Debt/total Asset Ratio.
  • But If we account as aquisition of business then, both ratio is increased as debt/ quity is increased by 0.96 or debt to total asset ration is increased by 0.03.

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