Case xx
Case 03-10
Painless, Inc.
The CEO of Painless, Inc. (Painless), a large publicly traded pharmaceutical
manufacturer, has contacted you to discuss a proposed stock investment that Painless
wishes to make. Under the terms of the proposed stock purchase agreement, Painless
would purchase $15 million of a new issuance of Series A Prefe
ed Stock in Pills-R-Us
(Pills), a small publicly traded pharmaceutical company that manufactures a pain-free
serum delivery device. Pills has been out of the development stage for several years and,
though it incu
ed losses from inception, the company is cu
ently in a net equity position
due to its strong recent performance. Pills’ cu
ent capital structure (before the Painless
transaction) is as follows:
Account December 31, 2001
Common Stock (8,920,000 shares, $.10 par value) $ XXXXXXXXXX,000
Additional Paid-In-Capital 20,387,000
Retained Earnings (5,468,000)
Total Shareholders’ Equity $ 15,811,000
Painless would purchase 100 percent of the new Series A Prefe
ed Stock for $7.50 per
share under the following terms:
• 8 percent cumulative dividend
• Convertible into common shares on 1-to-1 basis in 5 years
• Preference in liquidation
• Allow Painless to vote on an “as if” converted basis with the common stock
• Allow Painless to appoint 3 of 7 members of the board of directors
• Mandatorily redeemable upon certain specified changes in control of the company
Because Pills is expected to be profitable for the foreseeable future, Painless wishes to
account for its investment in Pills under the equity method, rather than simply as an
investment measured at cost. Management of both companies believes this is the best
accounting given the obvious significant influence exerted by Painless on Pills.
Required:
• Can Painless account for its investment in the Series A Prefe
ed Stock in Pills under
the equity method?
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