accounting

Your client, Great Value Hardware Stores, has come to you for assistance in evaluating an

opportunity to purchase a controlling interest in a hardware store in a neighboring city.

The store under consideration is a closely held family corporation. Owners of 60% of the

shares are willing to sell you the 60% interest, 30,000 common stock shares in exchange

for 7,500 of Great Value shares, which have a fair value of $40 each and a par value of

$10 each.

Your client sees this as a good opportunity to enter a new market. The controller of

Great Value knows, however, that all is not well with the store being considered. The store,

Al’s Hardware, has not kept pace with the market and has been losing money. It also has a

major lawsuit against it stemming from alleged faulty electrical components it supplied that

caused a fire. The store is not insured for the loss. Legal counsel advises that the store will

likely pay $300,000 in damages.

The following balance sheet was provided by Al’s Hardware as of December 31,

2011:

Assets Liabilities and Equity

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 180,000 Current liabilities . . . . . . . . . . . $ 425,000

Accounts receivable . . . . . . . . . . . . . . . 460,000 8% Mortgage payable . . . . . . 600,000

Inventory . . . . . . . . . . . . . . . . . . . . . . . . 730,000 Common stock ($5 par). . . . . . 250,000

Land. . . . . . . . . . . . . . . . . . . . . . . . . . . . 120,000 Paid-in capital in excess of par 750,000

Building. . . . . . . . . . . . . . . . . . . . . . . . . 630,000 Retained earnings . . . . . . . . . . (80,000)

Accumulated depreciation—building . . (400,000)

Equipment . . . . . . . . . . . . . . . . . . . . . . . 135,000

Accumulated depreciation—equipment (85,000)

Goodwill . . . . . . . . . . . . . . . . . . . . . . . . 175,000

Total assets. . . . . . . . . . . . . . . . . . . . . $1,945,000 Total liabilities and equity . . $1,945,000

Your analysis raises substantial concerns about the values shown. You have gathered

the following information:

1. Aging of the accounts receivable reveals a net realizable value of $350,000.

2. The inventory has many obsolete items; the fair value is $600,000.

3. Appraisals for long-lived assets are as follows:

Land. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $100,000

Building. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000

Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000

4. The goodwill resulted from the purchase of another hardware store that has since been con-

solidated into the existing location. The goodwill was attributed to customer loyalty.

5. Liabilities are fairly stated except that there should be a provision for the estimated loss on

the lawsuit.

On the basis of your research, you are convinced that the statements of Al’s Hardware

are not representative and need major restatement. Your client is not interested in being

associated with statements that are not accurate.

Your client asks you to make recommendations on two concerns:

1. Does the price asked seem to be a real bargain? Consider the fair value of the entire equity

of Al’s Hardware; then decide if the price is reasonable for a 60% interest.

2. If the deal were completed, what accounting methods would you recommend either on the

books of Al’s Hardware or in the consolidation process? Al’s Hardware would remain a

separate legal entity with a substantial noncontrolling interest.