CFA Practice Question

There are 334 practice questions for this study session.

CFA Practice Question

Octopus has recently acquired Guppy. Octopus needs to consolidate the financial statements of the two companies that were released recently.

The following things are disclosed:

  • Octopus issued 20 million shares worth $250 million to pay for the acquisition.
  • Guppy's fixed assets are actually worth $350 million at market prices.
  • Guppy's current assets should be marked down by $10 million due to bad accounts which have not been fully covered, which the liabilities on Guppy's balance sheet are correctly valued.
  • Octopus uses a 10-year straight line depreciation with no salvage value, while Guppy uses a 15-year straight line depreciation with no salvage value.

Under the acquisition method, the asset turnover ratio of the combined entity will be ______ that under the pooling of interests method.

A. higher than.
B. lower than.
C. the same as.
Correct Answer: B

The pooling of interests method would understate the value of assets of the combined entity by $40 million (350 - 300 = 50 due to revaluation of fixed assets, and -10 due to bad debts). The revenues are independent of the method applied. Therefore, the asset turnover ratio (revenue/assets) would be lower under the acquisition method.

User Contributed Comments 5

User Comment
ssradja you don't have to calculate anything here. just use some logic. asset turnover = sales/assets. assets under acquisition is higher, so asset turnover lower.
noonah Assets under acquisition method usually higher because Fair (market) value of assets are usually higher than book value, and possiblity of goodwill. However, if the question indicates assets are marked down, then it is the other way round.
vi2009 Acquisition method, we include goodwill as part of the assets. But pooling of method there is no goodwill (since it is b.v. to b.v.) overall as long as the net assets seem to be higher than prior period, there is no need for calculation for this question
quanttrader basically pooled method always gives more favorable numbers, and that's why it is discontinued.
davidt876 not necessarily quant. acquisition produces a better D/E ratio if for assets FV>BV and for liabilities FV<=BV ... because that would cause E to increase while D stayed the same or decreased:

A=E+L

although tbf that's literally the only favourable one i can think of
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