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paid was too high, and might result in a stock price decline (unless the market had already adjusted
for this overpayment prior to the actual writedown).

2-2
ANSWERS TO BUSINESS ETHICS CASE
a and b. The board has responsibility to look into anything that might suggest malfeasance or
inappropriate conduct. Such incidents might suggest broader problems with integrity, honesty, and
judgment. In other words, can you trust any reports from the CEO? If the CEO is not fired, does this
send a message to other employees that ethical lapses are okay? Employees might feel that top
executives are treated differently.

ANSWERS TO ANALYZING FINANCIAL STATEMENTS EXERCISES

AFS2-1 eBay acquires Skype

(A) Goodwill computation

Acquisition price $ 2,593 million

Net tangible and intangible assets 262 million
Goodwill $ 2,331 million

(B) Factors used to determine in the contingent consideration is part of the exchange or not. (FASB
ASC paragraphs 805-10-55-24 and 25)

The acquirer should consider the following if the contingent payments are made to employees or
selling shareholders.
1. Is the selling shareholder a continuing employee? If the contingent payment is canceled if
the employee’s employment is terminated, then the consideration might be post-acquisition
compensation for services.
2. If the selling shareholder is a continuing employee and the period of required continuing
employment is longer than the contingent payment period, the contingent payments might,
in substance, be compensation.
3. If the selling shareholder is a continuing employee and the employee’s compensation is
reasonable in comparison to other key employees, the contingent payment may indicate
additional consideration rather than compensation.
4. If the contingent payment for non-employees is less than the contingent payments for
continuing employees, the additional contingent payments for employees may indicated
compensation rather than additional consideration.

(C) It is not clear why eBay would settle the earnout for $530.3 million when the conditions for having
to make the additional contingent payments (up to $1.3 billion) were probably not going to be met.
Under current GAAP, if the amount of the contingent payment exceeded the previously expected
amount, the difference is reflected in earnings. Under the rules in effect for the Skype transaction the
contingent payment was simply an adjustment of goodwill. Because eBay was settling the earnout for
approximately a third of the total potential payments indicates that Skype was not performing well.
Notice that eBay wrote down$1.39 billion in goodwill at the same time. One potential reason that eBay
might have agreed to the payment is that the former CEO of Skype was stepping down and the
contingent payment may have been incentive for him to step down. In addition, the earnout may have
prevented eBay from selling Skype.

2-3
AFS2-2 eBay Sells Skype As Reported Adjustments Adjusted
eBay's Income Statement 2007 2008 2009 2007 2008 2009 2007 2008 2009
Net revenues $7,672,329 $8,541,261 $8,727,362 -364,564 -550,841 -620,403 $7,307,765 $7,990,420 $8,106,959
Cost of net revenues 1,762,972 2,228,069 2,479,762 -337,338 -434,588 -462,701 1,425,634 1,793,481 2,017,061
Gross profit 5,909,357 6,313,192 6,247,600 (27,226) (116,253) (157,702) 5,882,131 6,196,939 6,089,898
Operating expenses:
Sales and marketing 1,882,810 1,881,551 1,885,677 1,882,810 1,881,551 1,885,677
Product development 619,727 725,600 803,070 619,727 725,600 803,070
General & administrative 904,681 998,871 1,418,389 (343,200) 904,681 998,871 1,075,189
Provision for trans. &
loan
losses 293,917 347,453 382,825 293,917 347,453 382,825
Amortization of acquired
intangible assets 204,104 234,916 262,686 204,104 234,916 262,686
Restructuring 49,119 38,187 - 49,119 38,187
Impairment of goodwill 1,390,938 (1,390,938) - - -
Total operating
expenses 5,296,177 4,237,510 4,790,834 (1,390,938) (343,200) 3,905,239 4,237,510 4,447,634
Income from operations 613,180 2,075,682 1,456,766 1,363,712 (116,253) 185,498 1,976,892 1,959,429 1,642,264
Interest and other income 137,671 107,882 1,422,385 (1,400,000) 137,671 107,882 22,385
Income before income
taxes 750,851 2,183,564 2,879,151 1,363,712 (116,253) (1,214,502) 2,114,563 2,067,311 1,664,649

Provision for income taxes (402,600) (404,090) (490,054)

Net income $348,251 $1,779,474 $2,389,097

Ratios 2007 2008 2009 2007 2008 2009

Gross Margin Percentage 77.0% 73.9% 71.6% 7.5% 21.1% 25.4% 80.5% 77.6% 75.1%
Operating Margin
Percentage 8.0% 24.3% 16.7% 27.1% 24.5% 20.3%
Income before taxes % 9.8% 25.6% 33.0% 28.9% 25.9% 20.5%

There are four adjustments to eliminate the effect of Skype from eBay’s books. First, we eliminate the revenues and the direct expenses

2-3
AFS2-2 solution continued:

from each year. We eliminated 100% of Skype’s revenues and direct expenses disclosed in the footnotes
in 2009 because it was not clear from the disclosure whether those amounts were the amounts included
on eBay’s statements or whether they were for the entire year. An acceptable solution would be to
eliminate 11.5/12 or 95.8%. Second, the impairment of goodwill was added back in 2007. Third, the
gain on the sale of $1.4 million was subtracted from interest and other income in 2009. And finally, the
charge from the legal settlement was added back (or subtracted from costs) in 2009.

Performance: Including Skype, eBay’s gross margin declined from 77% to 71.6%. Without Skype, the
gross margin still declined, but the decline was smaller (80.5% to 75.1%). Including Skype, income
before taxes showed a rather large increase in absolute dollars increasing to $2,879,151 from $648,251
(283% increase). After Skype is eliminated we find a decreasing trend from $2,114,563 to 1,664,649 (a
21.3% decline). A similar trend exists for the income before tax as a percentage of revenues. The
unadjusted percentage increased from 9.8% to 33% while the adjusted percentage decreased from
28.9% to 20.5%. The most interesting aspect of the numbers is that eBay recorded an impairment charge
of $1.4 million in 2007 and then in 2009 recorded an $1.4 million gain on the sale.

2-4
AFS2-3 Measurement Period Adjustments and Contingent Consideration
A. The measurement period adjustment was made at the end of the year. FASB ASC Topic 805.30.35.1
states that some changes in the fair value of contingent consideration that the acquirer recognizes after
the acquisition date may be the result of additional information about facts and circumstances that
existed at the acquisition date that the acquirer obtained after that date. Such changes are measurement
period adjustments. However, changes resulting from events after the acquisition date, such as meeting
an earnings target, reaching a specified share price, or reaching a milestone on a research and
development project, are not measurement period adjustments. The company in the problem did not use
a measurement adjustment correctly because they state that ‘the initial terms of the agreement have not
been met.’ This is clearly an event that occurred after the date of the acquisition. The company should
write down the contingent consideration liability to zero and recognize a gain on revaluation. Note that
the English was not corrected in the footnote. They meant to write ‘the initial terms of the agreement
have not been met,’ but they wrote ‘have not be met’. Does this provide confidence to the user that the
numbers presented are correct?

B. The company is silent on the impairment of the intangible assets acquired.

What the company should have recorded:

Contingent consideration 367,500

Gain on revaluing (IS) 367,500

Impairment loss (IS) 577,500

Intellectual property 577,500

What the company actually recorded:

Acquisition Intellectual property 577,500
Date Common stock and PIC 210,000
Contingent consideration 367,500

Measurement Contingent consideration 376,500

Period Goodwill 210,000
Adjustment Intellectual property 577,500

Impairment Impairment loss (IS) 210,000

Goodwill 210,000

C. Although the overall impact on net income is the same (a reduction of net income of $210,000), the
company is supposed to estimate the fair value of the contingent consideration each quarter and record
the change in income. Using measurement period adjustments to ‘re-write’ history after events occur
gives a potentially misleading impression on the performance of the acquisition. Measurement period
adjustments are intended to adjust estimation made on the date of acquisition related to better
information about circumstances that existed on the date of acquisition, rather than circumstances that
arose subsequent to acquisition.

AFS2-4 Emdeon Inc. Acquisition of FVTech (Contingent Consideration)

1. Sellers often keep the cash on the date of the acquisition. Thus, they have incentives to delay
payments on debt and to attempt to collect receivables in advance. Including a working capital
arrangement helps to mitigate these incentive problems.
2. Contingent consideration is often used to help the acquirer and the acquiree to agree on a selling
price. The seller believes the company is worth more because of anticipated future performance and the
2-5
acquirer unsure about the exact future performance. However, the acquirer is more willing to pay more
for an acquisition if the future performance exceeds some critical level or if certain milestones are met
(such as regulatory approval of a drug patent).

The total potential contingent consideration offered is $40,000; thus the total potential consideration
offered is $60,303 ($20,005 cash, $58 working capital settlement, and $40,000 of contingent
consideration). Maximum contingent consideration to total potential consideration offered is 66.3
percent. The fair value of contingent consideration on the date of acquisition is $14,910 is 37.3 percent
of the maximum potential contingent consideration offered ($14,910/$40,000). The fair value of
contingent consideration on the date of acquisition is 42.6 percent of the total consideration offered on
the date of acquisition ($14,910/$34,973)/

3. Schedule of changes in fair value for contingent consideration

After Measurement Period Adjustment

1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
Fair value of contingent consideration
Beginning of quarter (or DOA) 14,910 13,850 13,850 13,850
Fair value at the end of quarter 15,200 13,210 11,580 7,170
Total change in fair value (290) 640 2,270 6,680

Previous years (gain) and losses 290 (930) (2,270)

Loss on change in fair value 290
(Gain) on change in fair value (930) (1,340) (4,410)

Totals -0- -0- -0- - 0-

4. Given that the fair value of the contingent consideration has been decreasing, it becomes less likely
that any contingent consideration will be paid. If not, reducing the liability for contingent consideration
will result in future gains recorded on the books (In theory, this partially offsets the expected lower
earnings.) Gains on reduction in the contingent consideration liability can signal future goodwill
impairments.

AFS2-5 Emdeon Inc. Acquisition of FVTech (Contingent Consideration)

1. The company did reassess the fair value estimates of the identifiable net assets but did not provide an
adequate description that the transaction resulted in a gain. The company merely restated the definition
of a bargain gain (i.e. that the transaction resulted in an excess of the value of the net assets acquired
over the purchase price).
2. A bargain purchase might happen, for example, in a business combination that is a forced sale in
which the seller is acting under compulsion. Also, sometimes the seller needs quick access to funds and
perhaps the number of buyers is limited (such as a bank with weak performance). The FASB has
struggled over time with bargain purchases because the FASB believes that the number of bargains
should be very small.
3.
Current Assets 24,910
Property, Plant, and Equipmetn 491
Due from Securitization 108,554
Identifiable intangible assets 67,200
Current Liabilities 8,500
Deferred taxes 12,527
2-6
Cash 158,901
Gain on bargain purchase 21,227

2-7
ANSWERS TO EXERCISES

Exercise 2-1

Part A Receivables 228,000

Inventory 396,000
Plant and Equipment 540,000
Land 660,000
Goodwill ($2,154,000 - $1,824,000) 330,000
Liabilities 594,000
Cash 1,560,000

Part B Receivables 228,000

Inventory 396,000
Plant and Equipment 540,000
Land 660,000
Liabilities 594,000
Cash 990,000
Gain on Business Combination ($1,230,000 - $990,000) 240,000

2-8
Exercise 2-2
Cash $680,000
Receivables 720,000
Inventories 2,240,000
Plant and Equipment (net) ($3,840,000 + $720,000) 4,560,000
Goodwill 120,000
Total Assets $8,320,000

Liabilities 1,520,000
Common Stock, $16 par ($3,440,000 + (.50  $800,000)) 3,840,000
Other Contributed Capital ($400,000 + $800,000) 1,200,000
Retained Earnings 1,760,000
Total Equities $8,320,000

Entries on Petrello Company’s books would be:

Cash 200,000
Receivables 240,000
Inventory 240,000
Plant and Equipment 720,000
Goodwill * 120,000
Liabilities 320,000
Common Stock (25,000  $16) 400,000
Other Contributed Capital ($48 - $16)  25,000 800,000

* ($48  25,000) – [($1,480,000 – ($800,000 – $720,000) – $320,000]

= $1,200,000 – [$1,480,000 – $80,000 – $320,000] = $1,200,000 – $1,080,000 = $120,000

2-9
 Exercise 2-3

Accounts Receivable 231,000

Inventory 330,000
Land 550,000
Buildings and Equipment 1,144,000
Goodwill 848,000
Allowance for Uncollectible Accounts ($231,000 - $198,000) 33,000
Current Liabilities 275,000
Bonds Payable 450,000
Premium on Bonds Payable ($495,000 - $450,000) 45,000
Preferred Stock (15,000$100) 1,500,000
Common Stock (30,000$10) 300,000
Other Contributed Capital ($25 - $10) 30,000 450,000
Cash 50,000

Cost paid ($1,500,000 + $750,000 + $50,000) = $2,300,000

Fair value of net assets (198,000 + 330,000 + 550,000 + 1,144,000 – 275,000 – 495,000) = 1,452,000
Goodwill = $848,000

Exercise 2-4

Cash 96,000
Receivables 55,200
Inventory 126,000
Land 198,000
Plant and Equipment 466,800
Goodwill* 137,450
Accounts Payable 44,400
Bonds Payable 480,000
Premium on Bonds Payable** 45,050
Cash 510,000

** Present value of maturity value, 12 periods @ 4%: 0.6246$480,000 = $299,808

Present value of interest annuity, 12 periods @ 4%: 9.38507$24,000 = 225,242
Total present value 525,050
Par value 480,000
Premium on bonds payable $ 45,050
*Cash paid $510,000
Less: Book value of net assets acquired ($897,600 – $44,400 – $480,000) (373,200)
Excess of cash paid over book value 136,800
Increase in inventory to fair value (15,600)
Increase in land to fair value (28,800)
Increase in bond to fair value 45,050
Total increase in net assets to fair value 650
Goodwill $137,450

2 - 10
Exercise 2-5

Part A Current Assets 960,000

Plant and Equipment 1,440,000
Goodwill 120,000
Liabilities 216,000
Cash 2,160,000
Liability for Contingent Consideration 144,000

Part B Loss on change in Fair Value of Contingent Consideration 56,000

Liability for Contingent Consideration 56,000

Part C Liability for Contingent Consideration 200,000

Gain on change in Fair Value of Contingent Consideration 200,000

Exercise 2-6

Part A Current Assets 960,000

Plant and Equipment 1,440,000
Goodwill 176,000
Liabilities 216,000
Cash 2,160,000
Liability for Contingent Consideration 200,000

Part B Liability for Contingent Consideration 200,000

Common Stock ($10 × 10,000) 100,000
Paid in Capital – Common Stock 100,000

Platz Company does not adjust the original amount recorded as equity.

Exercise 2-7

1. (c) Cost (8,000 shares @ $30) $240,000

Fair value of net assets acquired 228,800
Excess of cost over fair value (goodwill) $ 11,200

2. (c) Cost (8,000 shares @ $30) $240,000

Fair value of net assets acquired ($90,000 + $242,000 – $56,000) 276,000
Excess of fair value over cost (gain) $ 36,000

Exercise 2-8

Current Assets 362,000

Long-term Assets ($1,890,000 + $20,000) + ($98,000 + $5,000) 2,013,000
2 - 11
Goodwill * 395,000
Liabilities 119,000
Long-term Debt 491,000
Common Stock (144,000  $5) 720,000
Other Contributed Capital (144,000 $15 - $5)) 1,440,000

* (144,000 $15) – [$362,000 + $2,013,000 – ($119,000 + $491,000)] = $395,000

 $700,000  $20,000  = 144,000
Total shares issued   
 $5 $5 

Fair value of stock issued (144,000$15) = $2,160,000

Exercise 2-9
Case A
Cost (Purchase Price) $130,000
Less: Fair Value of Net Assets 120,000
Goodwill $ 10,000
Case B
Cost (Purchase Price) $110,000
Less: Fair Value of Net Assets 90,000
Goodwill $ 20,000
Case C
Cost (Purchase Price) $15,000
Less: Fair Value of Net Assets 20,000
Gain ($ 5,000)

Assets
Liabilities Retained
Goodwill Current Assets Long-Lived Assets
Earnings (Gain)
Case A $10,000 $20,000 $130,000 $30,000 0
Case B 20,000 30,000 80,000 20,000 0
Case C 0 20,000 40,000 40,000 5,000

2 - 12
Exercise 2-10
Part A.
2014: Step 1: Fair value of the reporting unit $400,000
Carrying value of unit:
Carrying value of identifiable net assets $330,000
Carrying value of goodwill ($450,000 - $375,000) 75,000
405,000
Excess of carrying value over fair value $ 5,000

The excess of carrying value over fair value means that step 2 is required.

Step 2: Fair value of the reporting unit $400,000

Fair value of identifiable net assets 340,000
Implied value of goodwill 60,000
Recorded value of goodwill ($450,000 - $375,000) 75,000
Impairment loss $ 15,000

2015: Step 1: Fair value of the reporting unit $400,000

Carrying value of unit:
Carrying value of identifiable net assets $320,000
Carrying value of goodwill ($75,000 - $15,000) 60,000
380,000
Excess of fair value over carrying value $ 20,000

The excess of fair value over carrying value means that step 2 is not required.

2016: Step 1: Fair value of the reporting unit $350,000

Carrying value of unit:
Carrying value of identifiable net assets $300,000
Carrying value of goodwill ($75,000 - $15,000) 60,000
360,000
Excess of carrying value over fair value $ 10,000

The excess of carrying value over fair value means that step 2 is required.

Step 2: Fair value of the reporting unit $350,000

Fair value of identifiable net assets 325,000
Implied value of goodwill 25,000
Recorded value of goodwill ($75,000 - $15,000) 60,000
Impairment loss $ 35,000

2 - 13
Part B.
2014: Impairment Loss—Goodwill 15,000
Goodwill 15,000

2015: No entry

2016: Impairment Loss—Goodwill 35,000

Goodwill 35,000
Part C.
SFAS No. 142 specifies the presentation of goodwill in the balance sheet and income statement (if
impairment occurs) as follows:
 The aggregate amount of goodwill should be a separate line item in the balance sheet.
 The aggregate amount of losses from goodwill impairment should be shown as a
separate line item in the operating section of the income statement unless some of the
impairment is associated with a discontinued operation (in which case it is shown
net-of-tax in the discontinued operation section).

Part D.
In a period in which an impairment loss occurs, SFAS No. 142 mandates the following disclosures
in the notes:
(1) A description of the facts and circumstances leading to the impairment;
(2) The amount of the impairment loss and the method of determining the fair value of
the reporting unit;
(3) The nature and amounts of any adjustments made to impairment estimates from
earlier periods, if significant.

Exercise 2-11

a. Fair Value of Identifiable Net Assets

Book values $500,000 – $100,000 = $400,000
Write up of Inventory and Equipment:
($20,000 + $30,000) = 50,000
Purchase price above which goodwill would result $450,000

b. Equipment would not be written down, regardless of the purchase price, unless it was
reviewed and determined to be overvalued originally.
c. A gain would be shown if the purchase price was below $450,000.
d. Anything below $450,000 is technically considered a bargain.
e. Goodwill would be $50,000 at a purchase price of $500,000 or ($450,000 + $50,000).

2 - 14
Exercise 2-12A

Cash 20,000
Accounts Receivable 112,000
Inventory 134,000
Land 55,000
Plant Assets 463,000
Discount on Bonds Payable 20,000
Goodwill* 127,200
Allowance for Uncollectible Accounts 10,000
Accounts Payable 54,000
Bonds Payable 200,000
Deferred Income Tax Liability 67,200
Cash 600,000

Cost of acquisition $600,000

Book value of net assets acquired ($80,000 + $132,000 + $160,000) 372,000
Difference between cost and book value 228,000
Allocated to:
Increase inventory, land, and plant assets to fair value ($52,000 + $25,000 + $71,000) (148,000)
Decrease bonds payable to fair value (20,000)
Establish deferred income tax liability ($168,00040%) 67,200
Balance assigned to goodwill $127,200

ANSWERS TO ASC (Accounting Standards Codification) EXERCISES

ASC2-1 Presentation Does current GAAP require that the information on the income statement be
reported in chronological order with the most recent year listed first, or is the reverse order acceptable as
well?
Alternative one:
Step 1: In the search box on the home page, enter ‘chronological order’.
Step 2: Two results are obtained.

Alternative two:
Step 1: Use the drop-down menus under the ‘presentation’ general topic on the homepage and choose
‘Presentation of financial statements’; then under the second drop-down menu, choose ’10-overall’.
Step 2: Click on the ‘Expand’ option and scroll through the topics looking for ‘chronological order’.
The very last line is SAB Topic 11.E Chronological Ordering of Data.

FASB ASC 205-10-S99-9 under SEC guidance indicates that the SEC staff have not preference in what
order the data are presented (e.g., the most current data displayed first, etc.) as long as all schedules in
the report are ordered in the same chronological order.

ASC2-2 General Principles In the 1990s, the pooling of interest method was a preferred method of
accounting for consolidations by many managers because of the creation of instant earnings if the
acquisition occurred late in the year. Can the firms that used pooling of interest in the 1990s continue to
use the method for those earlier consolidations, or were they required to adopt the new standards for
previous business combinations retroactively?

2 - 15
This issue is related to whether the rules for pooling of interest have been grandfathered or not.
Alternative one:
Step 1: Below the search box on the home page, click on ‘advanced search.’ Enter ‘Pooling of interests’
in the text/keyword box and click on exact phrase.
Step 2: Three results are obtained and the first alternative is the correct answer.

Alternative two:
Step 1: Use the drop-down menus under the ‘General Principles’ general topic on the homepage and
choose ‘Generally Accepted Accounting Principles’; then under the second drop-down menu, choose
’10-overall’.
Step 2: Section 70 is always the section for grandfathered guidance.

FASB ASC subparagraph 105-10-70-2(a) lists pooling of interests is listed as a grandfathered method.

ASC2-3 Glossary What instruments qualify as cash equivalents?

On the Codification homepage, click on ‘Master Glossary’ in the left-hand column. In the ‘glossary term
quick find’ menu type ‘cash equivalent’ and hit return.

Cash equivalents are short-term, highly liquid investments that have both of the following
characteristics:
a. Readily convertible to known amounts of cash
b. So near their maturity that they present insignificant risk of changes in value because of changes
in interest rates.

ASC2-4 Overview If guidance for a transaction is not specifically addressed in the Codification, what is
the appropriate procedure to follow in identifying the proper accounting?

The topic that established the Codification as authoritative GAAP is Topic 105.
Step 1: Use the drop-down menus under the ‘General Principles’ general topic on the homepage and
choose ‘Generally Accepted Accounting Principles’; then under the second drop-down menu, choose
’10-overall’.
Step 2: click on the red ‘Join all Sections’ button. Scroll through the paragraphs.

FASB ASC paragraph 105-10-05-2 states that if the guidance for a transaction or event is not specified
within a source of authoritative GAAP for that entity, an entity shall first consider accounting principles
for similar transactions or events within a source of authoritative GAAP for that entity and then consider
nonauthoritative guidance from other sources.

2 - 16
ASC2-5 General List all the topics found under General Topic 200—Presentation (Hint:There are 15
topics).

Presentation

205 Presentation of Financial Statements

210 Balance Sheet
215 Statement of Shareholder Equity
220 Comprehensive Income
225 Income Statement

230 Statement of Cash Flows

235 Notes to Financial Statements
250 Accounting Changes and Error Corrections
255 Changing Prices
260 Earnings Per Share

270 Interim Reporting

272 Limited Liability Entities
274 Personal Financial Statements
275 Risks and Uncertainties
280 Segment Reporting

ASC2-6 Cross-Reference The rules providing accounting guidance on subsequent events were
originally listed in FASB Statement No. 165. Where is this information located in the Codification? List
all the topics and subtopics in the Codification where this information can be found (i.e., ASC XXX-
XX).

Step 1: Choose the cross reference tab on the opening page of the Codification.
Step 2: Use the ‘By Standard’ drop down menu. Choose FAS as the standard type and 165 as the
standard number. Click on ‘Generate Report.’

FASB ASC subtopic 855-10 [, Subsequent Events – Overall]

ASC2-7 Overview Distinguish between an asset acquisition and the acquisition of a business.

This is a more difficult issue to find.

Alternative one:
Step 1: Below the search box on the home page, click on ‘advanced search.’ Enter ‘asset acquisition’ in
the text/keyword box and click on exact phrase.
Step 2: Sixteen results are obtained. You can narrow the search by clicking on ‘business combinations’
in the Narrow by related term section. Then, notice that the section on ‘related issues’ seems to be
where acquisition of assets rather than a business is located.

FASB ASC paragraph 805-50-05-3 states that the guidance in the ‘acquisition of assets rather than a
business’ subsections address transactions in which the assets acquired and liabilities assumed do not
constitute a business. A business is considered an integrated set of activities and assets that is capable of
being conducted and managed for the purpose of providing a return in the form of dividends, lower
costs, or other economic benefits directly to investors or other owners, members, or participants.

2 - 17
Alternative two:
Step 1: Use the drop-down menus under the ‘Broad Transactions’ general topic on the homepage and
choose ‘Business Combinations’; then under the second drop-down menu, choose ’10-overall’. Expand
the sections. Since nothing is listed related to the search, go to the scope section (805-10-15). FASB
ASC subparagraph 805-10-15-4(b) tells you the scope of section 10 does not cover asset acquisitions.
Step 2: Go back and search for ‘asset acquisition.

ASC2-8 Measurement GAAP requires that firms test for goodwill impairment on an annual basis. One
reporting unit performs the impairment test during January while a second reporting unit performs the
impairment test during July. If the firm reports annual results on a calendar basis, is this acceptable
under GAAP?

This can be a difficult issue to find depending on the student’s knowledge of goodwill. If a general
search is used with the term ‘goodwill impairment’ the correct section can be found. The student must
be aware that ‘subsequent measurement’ would be related to impairment testing of goodwill since
impairment tests are subsequent measurements of goodwill. However, since the correct paragraph is
paragraph 28, a lot of scrolling is needed.

Alternative two
Step 1: Use the drop-down menus under the ‘Assets’ general topic on the homepage and choose ‘350 –
Intangibles-Goodwill and other’; then under the second drop-down menu, choose ’20-Goodwill’.
Expand the sections. Since nothing is listed related to the search, go to the scope section (805-10-15).
FASB ASC subparagraph 805-10-15-4(b) tells you the scope of section 10 does not cover asset
acquisitions.
Step 2: click on subsequent measurement and click on ‘expand’ topics. One of the topics is ‘when to test
goodwill impairment’.

FASB ASC paragraph 350-20-35-28 states that different reporting units may be tested for impairment at
different times.

ANSWERS TO PROBLEMS

Problem 2-1

Current Assets 85,000

Plant and Equipment 150,000
Goodwill* 100,000
Liabilities 35,000
Common Stock [(20,000 shares @ $10/share)] 200,000
Other Contributed Capital [(20,000($15 – $10))] 100,000

Acquisition Costs Expense 20,000

Cash 20,000

Other Contributed Capital 6,000

Cash 6,000
To record the direct acquisition costs and stock issue costs

2 - 18
* Goodwill = Excess of Consideration of $335,000 (stock valued at $300,000 plus debt assumed of
$35,000) over Fair Value of Identifiable Assets of $235,000 (total assets of $225,000 plus PPE fair
value adjustment of $10,000)

Problem 2-2 Acme Company

Balance Sheet
October 1, 2011
(000)
Part A.
Assets (except goodwill) ($3,900 + $9,000 + $1,300) $14,200
Goodwill (1) 1,160
Total Assets $15,360

Liabilities ($2,030 + $2,200 + $260) $4,490

Common Stock (180$20) + $2,000 5,600
Other Contributed Capital (180($50 – $20)) 5,400
Retained Earnings (130)
Total Liabilities and Equity $15,360

(1) Cost (180$50) $9,000

Fair value of net assets acquired:
Fair value of assets of Baltic and Colt $10,300
Less liabilities assumed 2,460 7,840
Goodwill $1,160

2 - 19
Problem 2-2 (continued)

Part B.

Baltic
2015: Step1: Fair value of the reporting unit $6,500,000
Carrying value of unit:
Carrying value of identifiable net assets 6,340,000
Carrying value of goodwill 200,000*
Total carrying value 6,540,000
*[(140,000 x $50) – ($9,000,000 – $2,200,000)]
The excess of carrying value over fair value means that step 2 is required.

Step 2: Fair value of the reporting unit $6,500,000

Fair value of identifiable net assets 6,350,000
Implied value of goodwill 150,000
Recorded value of goodwill 200,000
Impairment loss $ 50,000

(because $150,000 < $200,000)

Colt
2015: Step1: Fair value of the reporting unit $1,900,000
Carrying value of unit:
Carrying value of identifiable net assets $1,200,000
Carrying value of goodwill 960,000*
Total carrying value 2,160,000
*[(40,000 x $50) – ($1,300,000 – $260,000)]
The excess of carrying value over fair value means that step 2 is required.

Step 2: Fair value of the reporting unit $1,900,000

Fair value of identifiable net assets 1,000,000
Implied value of goodwill 900,000
Recorded value of goodwill 960,000
Impairment loss $ 60,000

(because $900,000 < $960,000)

Total impairment loss is $110,000.

Journal entry:
Impairment Loss $110,000
Goodwill $110,000

2 - 20
Problem 2-3
Present value of maturity value, 20 periods @ 6%: 0.3118$600,000 = $187,080
Present value of interest annuity, 20 periods @ 6%: 11.46992$30,000 = 344,098
Total Present value 531,178
Par value 600,000
Discount on bonds payable $68,822

Cash 114,000
Accounts Receivable 135,000
Inventory 310,000
Land 315,000
Buildings 54,900
Equipment 39,450
Bond Discount ($40,000 + $68,822) 108,822
Current Liabilities 95,300
Bonds Payable ($300,000 + $600,000) 900,000
Gain on Purchase of Business 81,872

Computation of Excess of Net Assets Received Over Cost

Cost (Purchase Price) ($531,178 plus liabilities assumed of $95,300 and $260,000) $886,478
Less: Total fair value of assets received $968,350
Excess of fair value of net assets over cost ($ 81,872)

Problem 2-4
Part A January 1, 2014
Accounts Receivable 72,000
Inventory 99,000
Land 162,000
Buildings 450,000
Equipment 288,000
Goodwill* 19,000
Allowance for Uncollectible Accounts 7,000
Accounts Payable 83,000
Note Payable 180,000
Cash 720,000
Liability for Contingent Consideration 100,000

*Computation of Goodwill
Consideration paid ($720,000 + $100,000) $820,000
Total fair value of net assets acquired ($1,064,000 - $263,000) 801,000
Goodwill $ 19,000

2 - 21
Problem 2-4 (continued)

Part B January 2, 2013

Loss on Change in Fair Value of Contingent Consideration 20,000

Liability for Contingent Consideration 20,000

Part C January 2, 2013

Liability for Contingent Consideration 120,000

Gain from Change in Fair Value of Contingent Consideration 135,000

Problem 2-5 Pepper Company

Pro Forma Balance Sheet
Giving Effect to Proposed Issue of Common Stock and Note Payable for
All of the Common Stock of Salt Company under Purchase Accounting
December 31, 2013

Audited Pro Forma

Balance Sheet Adjustments Balance Sheet
Cash $180,000 405,000 $585,000
Receivables 230,000 (60,000) 287,000
117,000
Inventories 231,400 134,000 365,400
Plant Assets 1,236,500 905,000 (1) 2,141,500
Goodwill 181,500 181,500
Total Assets $1,877,900 $3,560,400

Accounts Payable $255,900 (60,000) $375,900

180,000
Notes Payable, 8% 0 300,000 300,000
Mortgage Payable 180,000 152,500 332,500
Common Stock, $20 par 900,000 600,000 1,500,000
Additional Paid-in Capital 270,000 510,000 (2) 780,000
Retained Earnings 272,000 272,000
Total Liabilities and Equity $1,877,900 $3,560,400

2 - 22
Problem 2-5 (continued)

Change in Cash
Cash from stock issue ($3730,000) $1,110,000
Less: Cash paid for acquisition (800,000)
Plus: Cash acquired in acquisition 95,000
Total change in cash $ 405,000

Goodwill:
Cost of acquisition $1,100,000
Net assets acquired ($340,000 + $179,500 + $184,000) 703,500
Excess cost over net assets acquired $396,500
Assigned to plant assets 215,000
Goodwill $ 181,500

(1) $690,000 + $215,000 (2) ($37- $20) 30,000

Problem 2-6 Ping Company

Pro Forma Income Statement for the Year 2014
Assuming a Merger of Ping Company and Spalding Company

Sales (1) $6,345,972

Cost of goods sold:
Fixed Costs (2) $824,706
Variable Costs (3) 2,464,095 3,288,801
Gross Margin 3,057,171

Selling Expenses (4) $785,910

Other Expenses (5) 319,310 1,105,220

Net Income $1,951,951

$1,951,951 – ($952,640 + $499,900) = $499,411 = $2,497,055

0.20 0.20
Since $2,497,055 is greater than $1,800,000 Ping should buy Spalding.

(1) $3,510,100 + $2,365,800 = $5,875,9001.2.9 = $6,345,972

(2) ($1,752,360.30) + ($1,423,800.30.70) = $824,706

$5,875,900 1.2
(3) $1,752,360.70 = $2,464,095
$3,510,100
(4) ($632,500 + $292,100).85 = $785,910

(5) $172,6001.85 = $319,310

2 - 23
Problem 2-7A

Part A Receivables 125,000

Inventory 195,000
Land 120,000
Plant Assets 567,000
Patents 200,000
Deferred Tax Asset ($60,000 x 35%) 21,000
Goodwill* 154,775
Current Liabilities 89,500
Bonds Payable 300,000
Premium on Bonds Payable 60,000
Deferred Tax Liability 93,275
Common Stock (30,000$2) 60,000
Other Contributed Capital (30,000$26) 780,000

Cost of acquisition (30,000$28) $840,000

Book value of net assets acquired ($120,000 + $164,000 + $267,000) 551,000
Difference between cost and book value 289,000
Allocated to:
Increase inventory, land, plant assets, and patents to fair value (266,500)
Deferred income tax liability (35%$266,500) 93,275
Increase bonds payable to fair value 60,000
Deferred income tax asset (35%$60,000) (21,000)
Balance assigned to goodwill $154,775

Part B Income Tax Expense (Balancing amount) 148,006

Deferred Tax Liability ($51,12535%)* 17,894
Deferred Tax Asset ($6,00035%) 2,100
Income Tax Payable ($468,00035%) 163,800

* Inventory: $28,000
$100,000
Plant Assets, 10,000
10
$105,000
Patents, 13,125
8
Total $51,125

2 - 24
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 THE CITY IN RUINS.
Richard Spillane, a well-known Galveston newspaper man and
day correspondent of the Associated Press in that city, who reached
Houston September 10th, after a terrible experience, gives the
following account of the disaster at Galveston:

FIRST BAPTIST CHURCH, GALVESTON,

AFTER THE STORM

WRECKAGE OF CARS OF GRAIN—

GALVESTON
 AVENUE L AND TWENTY-SIXTH STREET,
SHOWING THE URSULINE CONVENT, THE
REFUGE OF HUNDREDS OF PEOPLE

RUINS OF THE GAS WORKS AT THIRTY-

THIRD AND MARKET STREETS
BURYING BODIES WHERE THEY WERE
FOUND

AVENUE L AND FIFTEENTH STREET—

SHOWING DESTRUCTION DONE BY THE
HURRICANE
 TANGLED MASS OF RUINS ON NINETEENTH
STREET

VOLUNTEERS REMOVING DEBRIS ON

TWENTY-FIRST STREET, LOOKING SOUTH

“One of the most awful tragedies of modern times has visited

Galveston. The city is in ruins, and the dead will number many
thousands: I am just from the city, having been commissioned by the
Mayor and Citizens’ Committee to get in touch with the outside
world and appeal for help. Houston was the nearest point at which
working telegraph instruments could be found, the wires as well as
nearly all the buildings between here and the Gulf of Mexico being
wrecked.
 “When I left Galveston the people were organizing for the
prompt burial of the dead, distribution of food and all necessary
work after a period of disaster.
 CITY TURNED INTO A RAGING SEA.
“The wreck of Galveston was brought about by a tempest so
terrible that no words can adequately describe its intensity, and by a
flood which turned the city into a raging sea. The Weather Bureau
records show that the wind attained a velocity of eighty-four miles an
hour when the measuring instrument blew away, so it is impossible
to tell what was the maximum.
“The storm began at 2 o’clock Saturday morning. Previous to
that a great storm had been raging in the Gulf, and the tide was very
high. The wind at first came from the north, and was in direct
opposition to the force from the Gulf. Where the storm in the Gulf
piled the water up on the beach side of the city, the north wind piled
the water from the bay onto the bay part of the city.
“About noon it became evident that the city was going to be
visited with disaster. Hundreds of residences along the beach front
were hurriedly abandoned, the families fleeing to dwellings in higher
portions of the city. Every home was opened to the refugees, black or
white. The winds were rising constantly, and it rained in torrents.
The wind was so fierce that the rain cut like a knife.
“By 3 o’clock the waters of the Gulf and bay met, and by dark the
entire city was submerged. The flooding of the electric light plant and
the gas plants left the city in darkness. To go upon the streets was to
court death. The wind was then at cyclonic velocity, roofs, cisterns,
portions of buildings, telegraph poles and walls were falling, and the
noise of the wind and the crashing of buildings were terrifying in the
extreme. The wind and waters rose steadily from dark until 1.45
o’clock Sunday morning. During all this time the people of Galveston
were like rats in a trap. The highest portion of the city was four to
five feet under water, while in the great majority of cases the streets
were submerged to a depth of ten feet. To leave a house was to
drown. To remain was to court death in the wreckage.
“Such a night of agony has seldom been equaled. Without
apparent reason the waters suddenly began to subside at 1.45 A. M.
Within twenty minutes they had gone down two feet, and before
daylight the streets were practically freed of the flood-waters. In the
meantime the wind had veered to the southeast.
 VERY FEW BUILDINGS ESCAPED.
“Very few if any buildings escaped injury. There is hardly a
habitable dry house in the city. When the people who had escaped
death went out at daylight to view the work of the tempest and floods
they saw the most horrible sights imaginable. In the three blocks
from Avenue N to Avenue P, in Tremont street, I saw eight bodies.
Four corpses were in one yard.
“The whole of the business front for three blocks in from the
Gulf was stripped of every vestige of habitation, the dwellings, the
great bathing establishments, the Olympia and every structure
having been either carried out to sea or its ruins piled in a pyramid
far into the town, according to the vagaries of the tempest. The first
hurried glance over the city showed that the largest structures,
supposed to be the most substantially built, suffered the greatest.
“The Orphans’ Home, Twenty-first street and Avenue M, fell like
a house of cards. How many dead children and refugees are in the
ruins could not be ascertained. Of the sick in St. Mary’s Infirmary,
together with the attendants, only eight are understood to have been
saved. The Old Woman’s Home, on Roosenburg avenue, collapsed,
and the Roosenburg School-house is a mass of wreckage. The Ball
High School is but an empty shell, crushed and broken. Every church
in the city, with possibly one or two exceptions, is in ruins.
“At the forts nearly all the soldiers are reported dead, they
having been in temporary quarters, which gave them no protection
against the tempest or flood. No report has been received from the
Catholic Orphan Asylum down the island, but it seems impossible
that it could have withstood the hurricane. If it fell, all the inmates
were, no doubt, lost, for there was no aid within a mile.
“The bay front from end to end is in ruins. Nothing but piling
and the wreck of great warehouses remain. The elevators lost all their
super-works, and their stocks are damaged by water. The life-saving
station at Fort Point was carried away, the crew being swept across
the bay fourteen miles to Texas City. I saw Captain Haynes, and he
told me that his wife and one of his crew were drowned.
 WRECKAGE SWEPT ACROSS THE BAY.
“The shore at Texas City contains enough wreckage to rebuild a
city. Eight persons who were swept across the bay during the storm
were picked up there alive. Five corpses were also picked up. There
were three fatalities in Texas City. In addition to the living and the
dead which the storm cast up at Texas City, caskets and coffins from
one of the cemeteries at Galveston were being fished out of the water
there yesterday. In the business portion of the city two large brick
buildings, one occupied by Knapp Brothers and the other by the
Cotton Exchange saloon, collapsed. In the Cotton Exchange saloon
there were about fifteen persons. Most of them escaped.
“The cotton mills, the bagging factory, the gas works, the electric
light works and nearly all the industrial establishments of the city are
either wrecked or crippled. The flood left a slime about one inch deep
over the whole city, and unless fast progress is made in burying
corpses and carcasses of animals there is danger of pestilence. Some
of the stories of the escapes are miraculous. William Nisbett, a cotton
man, was buried in the ruins of the Cotton Exchange saloon, and
when dug out in the morning had no further injury than a few
bruised fingers.
“Dr. S. O. Young, Secretary of the Cotton Exchange, was
knocked senseless when his house collapsed, but was revived by the
water, and was carried ten blocks by the hurricane. A woman who
had just given birth to a child was carried from her home to a house a
block distant, the men who were carrying her having to hold her high
above heads, as the water was five feet deep when she was moved.
“Many stories were current of houses falling and inmates
escaping. Clarence N. Ousley, editor of the Evening Tribune, had his
family and the families of two neighbors in his house when the lower
half crumbled and the upper part slipped down into the water. No
one in the house was hurt.
“The Mistrot House, in the West End, was turned into a hospital.
All of the regular hospitals of the city were unavailable. Of the new
Southern Pacific Works little remains but the piling. Half a million
feet of lumber was carried away, and Engineer Boschke says, as far as
the company is concerned, it might as well start over again.
 EIGHT OCEAN STEAMERS STRANDED.
“Eight ocean steamers were torn from their moorings and
stranded in the bay. The Kendall Castle was carried over the flats at
Thirty-third street wharf to Texas City, and lies in the wreckage of
the Inman pier. The Norwegian steamer Gyller is stranded between
Texas City and Virginia Point. An ocean liner was swirled around
through the west bay, crashed through the bay bridges, and is now
lying in a few feet of water near the wreckage of the railroad bridges.
“The steamship Taunton was carried across Pelican Point and is
stranded about ten miles up the east bay. The Mallory steamer
Alamo was torn from her wharf and dashed upon Pelican flats, and
against the bow of the British steamer Red Cross, which had
previously been hurled there. The stern of the Alamo is stove in and
the bow of the Red Cross is crushed. Down the channel to the jetties
two other ocean steamships lie grounded. Some schooners, barges
and smaller craft are strewn bottom side up along the slips of the
piers. The tug Louise, of the Houston Direct Navigation Company, is
also a wreck.
“It will take a week to tabulate the dead and the missing and to
get anything near an approximate idea of the monetary loss. It is safe
to assume that one-half the property of the city is wiped out, and that
one-half of the residents have to face absolute poverty.
“At Texas City three of the residents were drowned. One man
stepped into a well by a mischance and his corpse was found there.
Two other men ventured along the bay front during the height of the
storm and were killed. There are but few buildings at Texas City that
do not tell the story of the storm. The hotel is a complete ruin. The
office of the Texas City Company was almost entirely destroyed.
Nothing remains of the piers except the piling.
“The wreckage from Galveston litters the shore for miles and is a
hundred yards wide. For ten miles inland from the shore it is a
common sight to see small craft, such as steam launches, schooners
and oyster sloops. The life boat of the life-saving station was carried
half a mile inland, while a vessel that was anchored in Moses Bayou
lies high and dry five miles up from La Marque.
 MULTITUDES SWEPT OUT TO SEA.
“From Virginia Point north and south along the bay front, at
such places as Texas City, Dickinson, Hitchcock, Seabrook, Alvin and
a dozen small intermediate points, the number of dead bodies
gathered up by rescue trains and sailing craft had reached at noon
more than 700. This is only a small scope of the country devastated,
and it is feared the death list from the storm will ultimately show not
less than 5000 victims. Hundreds have been swept out to sea who
will never be accounted for. Two mass meetings were held at Dallas,
and many thousands of dollars were subscribed for the relief of the
Texas Gulf coast storm sufferers.”
The towns of Sabine Pass and Port Arthur, news from which was
anxiously awaited, passed through the terrific storm virtually
unscathed. At Port Arthur the water spread over the town, but it did
not reach a depth sufficient to destroy buildings. The town pleasure
pier was washed away completely, as was also the pier in front of the
Gales and Elwood Homes. The dredge Florida, property of the New
York Dredging Company, which cut the Port Arthur Channel, sunk at
the mouth of Taylor Bayou. No other property of consequence was
injured.
At Sabine Pass the water reached a depth of about three feet, but
nothing except small buildings near the water-front were washed
away. Several mud-scows and sloops were washed ashore. The
Southern Pacific wharves and warehouses were not damaged in the
least. The railroad between Beaumont and Sabine Pass was under
water for a distance of twelve miles, but not more than four miles
were washed out. The life-saving station of Sabine Pass was washed
from its blocks, but the light tower was not damaged. There was
considerable damage at Sabine Pass by water rising into the streets.
 ARMY TENTS AND RATIONS FOR THE
SUFFERERS.
The officers of the National Government took steps at once to
render all possible aid and assistance to the flood-sufferers of Texas.
The President sent telegrams of sympathy to the Governor of the
State and the Mayor of Galveston, and promised to render all
possible relief. Adjutant-General Corbin also telegraphed
instructions to General McKibbin, commanding the Department of
Texas at San Antonio, to proceed to Galveston and investigate the
character and extent of the damage caused by the hurricane, and to
report to the Secretary of War what steps were necessary to alleviate
the sufferings of the people and improve the situation.
Battery O, First Artillery, which garrisoned Fort San Jacinto,
was commanded by Captain William C. Rafferty. First Lieutenant
Lassiter was on detail duty at West Point, but the Second Lieutenant,
J. C. Nichols, was with his company during the storm. Acting
Secretary of the Treasury Spalding ordered two revenue cutters, one
at Norfolk and one at Wilmington, N.C., to proceed at once to
Mobile, Ala., and there await orders. They were needed in supplying
food and tents to the storm-sufferers.
Governor Sayers, of Texas, applied to the War Department for
10,000 tents and 50,000 rations for immediate use for the sufferers.
Acting Secretary Meiklejohn issued an order granting the request.
The tents were sent from San Antonio and Jefferson Barracks,
Missouri. A large portion of the rations was procured at San Antonio.
 AN APPEAL FROM HOUSTON.
The following telegrams passed between the White House and
Texas:

“Houston, Texas, September 10.—William McKinley, President

of the United States, Washington, D. C.: I have been deputized by the
Mayor and Citizens’ Committee of Galveston to inform you that the
city of Galveston is in ruins, and certainly many hundreds, if not a
thousand, are dead. The tragedy is one of the most frightful in recent
times. Help must be given by the State and Nation or the suffering
will be appalling. Food, clothing and money will be needed at once.
The whole south side of the city for three blocks in from the Gulf is
swept clear of every building, the whole wharf front is a wreck and
but few houses in the city are really habitable. The water supply is cut
off and the food stock damaged by salt water. All bridges are washed
away, and stranded steamers litter the bay. When I left this morning
the search for bodies had begun. Corpses were everywhere. Tempest
blew eighty-four miles an hour, and then carried Government
instruments away. At same time waters of Gulf were over whole city,
having risen twelve feet. Water has now subsided, and the survivors
are left helpless among the wreckage, cut off from the world except
by boat.
“Richard Spillane.”

“Washington, September 10.—Hon. J. D. Sayers, Governor of

Texas, Austin, Texas: The reports of the great calamity which has
befallen Galveston and other points on the coast of Texas excite my
profound sympathy for the sufferers, as they will stir the hearts of the
whole country. Whatever help it is possible to give shall be gladly
extended. Have directed the Secretary of War to supply rations and
tents upon your request.
 “William McKinley.”

A copy of this telegram was sent to the Mayor of Galveston as

well as to Governor Sayers.

“Austin, Texas, September 10.—The President, Washington:

Very many thanks for your telegram. Your action will be greatly
appreciated and gratefully remembered by the people of Texas. I
have this day requested the Secretary of War to forward rations and
tents to Galveston.
“Joseph D. Sayers,
“Governor of Texas.”
 CLARA BARTON READY FOR RELIEF
WORK.
Miss Clara Barton issued the following appeal in behalf of the
Texas sufferers:

“The American National Red Cross, at Washington, D. C., is

appealed to on all sides for help and for the privilege to help in the
terrible disaster which has befallen Southern and Central Texas. It
remembers the floods of the Ohio and Mississippi, of Johnstown,
and of Port Royal, with their thousands of dead and months of
suffering and needed relief, and turns confidently to the people of the
United States, whose sympathy has never failed to help provide the
relief that is asked of it now. Nineteen years of experience on nearly
as many fields renders the obligations of the Red Cross all the
greater. The people have long learned its work, and it must again
open its accustomed avenues for their charities. It does not beseech
them to give, for their sympathies are as deep and their humanity as
great as its own, but it pledges to them faithful old-time Red Cross
relief work among the stricken victims of these terrible fields of
suffering and death.
“He gives twice who gives quickly.
“Contributions may be wired or sent by mail to our Treasurer,
William J. Flather, Assistant Cashier Riggs National Bank,
Washington, D. C.; also to the local Red Cross committees of the Red
Cross India Famine Fund, at 156 Fifth avenue, New York City, and
the Louisiana Red Cross of New Orleans, both of whom will report all
donations for immediate acknowledgment by us.
“Clara Barton,
“President National American Red Cross.”
 Miss Barton telegraphed Governor Sayers, at Austin, Tex., as
follows:
“Do you need the Red Cross in Texas? We are ready.”
 THE DESTRUCTION INLAND.
Later details show that from Red River on the north to the Gulf
on the south and throughout the central part of the State, Texas was
storm-swept by a hurricane which laid waste property, caused large
loss of life, and effectually blocked all telegraphic and telephonic
communication south, while the operation of trains was seriously
handicapped.
Starting with the hurricane which visited Galveston and the Gulf
coast Saturday noon, and which was still prevailing there to such an
extent that no communication could be had with the island to
ascertain what the loss to life and property was, the storm made
rapid inroads into the centre of the State, stopping long enough at
Houston to damage over half of the buildings of that city.
Advancing inland, the storm swept into Hempstead, fifty miles
above Houston, thence to Chappell Hill, twenty miles further; thence
to Brenham, thirty miles further, wrecking all three towns. Several
persons were killed.
The Brazos bottom suffered a large share of damage at the hands
of the hurricane, and was swept for fully 100 miles of its length,
everything being turned topsy-turvy by the high winds, and much
destruction resulting to crops as well as farmhouse property. The
winds were accompanied by a heavy rainfall, which served to add to
the horror of midnight. The telegraph and telephone companies have
large forces of men trying to rig up wires to Galveston. The storm
seems to have swept all the tableland clear of everything on it, razing
houses to the ground and tearing up trees by the roots. It also swept
into the mountain gorges and there inflicted the worst damage, and
considerable loss of life was reported from that section. From
Southwest Texas and points along the Gulf to the city of Galveston
the reports were alarming. A number of parties summering at
various points along the coast were not heard from. The cotton was
nearly ruined, as the storm swept the cotton-belt.
 CHAPTER III.
Incidents of the Awful Hurricane—
Unparalleled Atrocities by Lawless Hordes—
Earnest Appeals for Help.

O n September 11th, the Mayor of Galveston forwarded the

following address to the people of the United States:

“It is my opinion, based on personal information, that 5000

people have lost their lives here. Approximately one-third of the
residence portion of the city has been swept away.
“There are several thousand people who are homeless and
destitute. How many, there is no way of finding out. Arrangements
are now being made to have the women and children sent to
Houston and other places, but the means of transportation are
limited. Thousands are still to be cared for here. We appeal to you for
immediate aid.
“WALTER C. JONES.”

On the same date the following statement of conditions at

Galveston and appeal for aid was issued by the local relief
committee:
“A conservative estimate of the loss of life is that it will reach at
least 5,000, and at least that number of families are shelterless and
wholly destitute. The entire remainder of the population is suffering
in a greater or less degree. Not a single church, school or charitable
institution, of which Galveston had so many, is left intact. Not a
building escaped damage, and half the whole number were entirely
obliterated. There is immediate need for food, clothing and
household goods of all kinds. If nearby cities will open asylums for
women and children, the situation will be greatly relieved. Coast
cities should send us water, as well as provisions, including kerosene,
oil, gasoline and candles.
“W. C. Jones, mayor; M. Lasker, president Island City Saving
Bank; J. D. Skinner, president Cotton Exchange; C. H. McMaster, for
Chamber of Commerce; R. G. Lowe, manager Galveston News;
Clarence Owsley, manager Galveston Tribune.”
The white cotton screw men’s organization held a meeting and
tendered their services, that of 500 able bodied men, to the public
committee to clear the streets of debris. Big forces went to work, and
the situation was much improved so far as the passage of vessels was
concerned. The city was patrolled by regular soldiers and citizen
soldiery. No one was allowed on the streets without a pass. Several
negroes were shot for not halting when ordered.
The steamer Lawrence arrived here early on the morning of the
11th, from Houston, with water and provisions. A committee of one
hundred citizens were aboard, among them being doctors and cooks.
W. G. Van Vleck, General Manager of the Southern Pacific Railroad,
arrived at the same time. He thought it would be possible to establish
mail service from Houston to Texas City by night, with transfer boats
to Galveston.
 BODIES BEING BURIED IN TRENCHES.
It was found to be impossible to send bodies to sea for burial.
The water receded so far, however, that it was possible to dig
trenches, and bodies were being buried where found. Debris covering
bodies was being burned where it could be done safely.
Work on the water works was rushed, and it was hoped to be
able to turn a supply on in the afternoon.
Outside of Galveston smaller towns were beginning to send in
reports as telegraphic communication improved, and many additions
to the list of the dead and property losses were received. Richmond
and Hitchcock each reported sixteen lives lost. Alto Loma, Arcadia,
Velasco, Seabrooke, Belleville, Areola and many other towns had
from one to eight dead. In most of these places many houses were
totally destroyed and thousands of head of live stock killed.
The railroads alone suffered millions of dollars in actual
damage, to say nothing of the loss from stoppage of business. The
International and Great Northern and Santa Fe had miles of track
washed out, and the bridges connecting Galveston with the mainland
must be entirely rebuilt.
The following is the description of an eye-witness on September
11: “Galveston is almost wiped off the earth. Fifteen thousand
persons are homeless. The loss of life will reach into the thousands.
Bodies are piled everywhere.
“When daylight broke over the expanse of floating bodies,
rubbish heaps and ruins were all that remained of the prosperous
city. A few leading citizens assembled in several feet of water at a
street corner and called a meeting at the Tremont Hall, to which they
adjourned. A committee of Public Safety of fifteen leading citizens
was formed, and Colonel J. H. Hawley, one of the best known men in
Texas, was made chairman. He, with Mayor Walter C. Jones and
Chief of Police Edward Ketchum, formed a triumvirate, with absolute
power, and declared the city under martial law.
 MILITARY FORCES AND SPECIAL POLICE.
“They issued a commission to Major L. R. D. Fayling, which
made him commander-in-chief of all military forces and special
deputies of police, and only subject to the orders of the Mayor and
the Chief of Police. Major Fayling was authorized to requisition any
men or property he may require for his force, and his receipt will be
honored by the city of Galveston and any such property paid for by
the city.
“As soon as Major Fayling received his authority he collected a
handful of half-naked, barefooted soldiers, clothed them, supplied
them with food and put them under command of Captain Edward
Rogers. Around this nucleus of a force he has built up to meet the
necessities of the situation his present force of three full companies
of volunteer soldiers and a troop of cavalry.
“A horde of negroes and whites—even white women—were in
the ruins of the city. They were robbing the dead and dying, killing
those who resisted, cutting off fingers to obtain rings and ears to
obtain earrings. Drunken men reeled about the streets intimidating
citizens.
“Chief of Police Ketchum ordered the sale of liquor stopped, and
began to swear in hundreds of special policemen to rescue the
wounded, feed the living and convey the dead to a hundred different
morgues. He worked for thirty-six hours without going home to
inquire about his family’s fate, which was in doubt. When told he
should do so he replied, characteristically, ‘God will be good to me
and mine, for I am going to be good to others.’
 THE STENCH UNBEARABLE.
“The stench from the dead by Monday morning was unbearable.
The triumvirate ruling the city pressed citizens into service to take
the dead out in barges and bury them in the Gulf. The soldiers
impressed into service, at the point of the bayonet, every wagon that
came along and every negro to assist in throwing the dead into the
sea. It was impossible to give other burial.
“From the stench which pervades the city it is apparent that
hundreds of bodies yet lie under the ruins. The sun is hotter than in
July. The regular soldiers, who had been working for two days with
bloody feet, were utterly exhausted by Monday evening, and were
assembled by Captain Rafferty and put in a hastily extemporized
hospital, which was formerly a church. Their places were filled by
Major Fayling with new recruits, whom he drafted on the streets and
supplied with arms and equipment from the local armory.
“Every part of the city was patrolled by 6 o’clock in the evening.
Among many other incidents of last night was the besieging of the
squad guarding St. Mary’s Hospital. They were surrounded by a
horde of armed negro thieves. Several hundred shots were
exchanged. Sergeant Camp killed four negroes with his rifle, and
about ten or twelve were killed by the squad. The soldiers have since
been picketing the city, doing fourteen hours’ duty without rest.
Every hour during the night a fresh negro shooting was reported at
headquarters.
“The tug ‘Juno’ and the propeller ‘Lawrence’ brought 2000
gallons of water here from Houston but the supply is not enough to
go around, and half the population is without any water. Breakfast at
the $4 per day hotel Tremont was served to a fortunate few to-day,
and consisted of a small piece of bacon and a single cup of coffee.
The hotel was untenable yesterday, and guests were refused. It is
jammed to-day with local citizens who have been made homeless.”
G. W. Ware, teacher of penmanship in a Dallas educational
institution, was in Galveston during the hurricane. He reached Dallas
on Tuesday, the 11th and made the following statement:
 WORK OF HEARTLESS CRIMINALS.
“It was a godsend, the placing of the city under martial law. The
criminal element began looting the dead, and the cold blooded
commercial element began looting the living. The criminals were
stealing anything they could with safety lay hands on, and the
mercenary commercial pirates began a harvest of extortion. The
price of bacon was pushed up to 50 cents a pound, bread 60 cents a
loaf, and owners of small schooners and other sailing craft formed a
trust, and charged $8 a passenger for transportation across the bay
from the island to the mainland.
“Mayor Jones and other men of conscience were shocked at
these proceedings, and the Mayor decided that the only protection
for the citizens would be to declare martial law, confiscate all
foodstuffs and other necessities for the common good, and thus stop
the lootings and holdups.
“The price of bread was reduced to 10 cents a loaf, bacon was
placed at 15 cents a pound, and the price of a voyage across the bay
was set at $1.50 a passenger. A book account is being kept of all sales
of foodstuffs, and other transactions and settlements will be made at
the scheduled rates.”
Mr. Quinlan, General Manager of the Houston and Texas
Central Railroad, said:
“It is in such cases as this Galveston disaster that the barbarity
in some men is seen. I have seen enough in the last two days to
convince me that a large element of civilized mankind are veneered
savages. My policy would be to take nobody into Galveston except
such persons as are absolutely needed to administer to the
distressed. Thousands of residents of Galveston ought to be brought
out of there as fast as boats can bring them to the mainland, and
establish them in charity or detention camps on high ground, where
they can get pure air and water and receive attention which cannot
be given to them on the island.
“I hope Governor Sayres will find authority to enforce some such
policy. This relief work is going to be an all-winter task. Persons who
have lost homes and places of business must be taken charge of until
they can properly take care of themselves.”
 THE FINANCIAL OUTCOME.
The effect that Galveston’s disaster may have upon the financial
obligations of that city was an interesting topic among local
financiers. Whether the bonds will be paid when due or whether
interest default will result when coupons are presented is a mooted
question in certain circles. J. B. Adone, banker, of Dallas, and former
member of the old banking firm of Flippin, Adone & Lobit, of
Galveston, said concerning these points:
“Galveston’s bond and interest obligations will be promptly met,
I feel sure. If left to their own resources in the face of the present
calamity, the people of Galveston and their public officials would be
probably temporarily embarrassed, but there will be no repudiation
or defalcation. The people of Texas will respond to the needs of
Galveston in her present terrible affliction, and out of the moneys
contributed the city’s financial credit will be protected if this course
should be found necessary.”
Pursuant to the proclamation of Mayor Brashear, issued Sunday
night, a citizens’ meeting was held in the city council chamber at
Houston and an organization effected for the relief of the victims of
the storm. The following telegram was received by the Mayor from
Governor Sayres:

“Austin, Texas, Sept. 10.—I have taken the liberty of directing

that all supplies of food and clothing for Galveston be shipped to you.
Will you undertake to forward them when received to Galveston for
distribution? Answer quick.
“JOSEPH D. SAYRES, Governor.”

Mayor Brashear immediately replied that all supplies would be

distributed where mostly needed. A telegram from Areola was
received, and there were twenty-five persons there, mostly women
and children, in urgent need of relief.
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