ADVANCE ACCOUNTING Ch05

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Allocation and Depreciation of Allocation and Depreciation of Differences Between Implied and Differences Between Implied and Book Values AcquisitionBook Values Acquisition

Advanced Accounting, Fifth Edition

55

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1. Calculate the difference between implied and book values and allocate to the subsidiary’s assets and liabilities.

2. Describe FASB’s position on accounting for bargain acquisitions.3. Explain how goodwill is measured at the time of the acquisition.4. Describe how the allocation process differs if less than 100% of the subsidiary

is acquired.5. Record the entries needed on the parent’s books to account for the investment

under the three methods: the cost, the partial equity, and the complete equity methods.

6. Prepare workpapers for the year of acquisition and the year(s) subsequent to the acquisition, assuming that the parent accounts for the investment using the cost, the partial equity, and the complete equity methods.

7. Understand the allocation of the difference between implied and book values to long-term debt components.

8. Explain how to allocate the difference between implied and book values when some assets have fair values below book values.

9. Distinguish between recording the subsidiary depreciable assets at net versus gross fair values.

10. Understand the concept of push down accounting.

Learning ObjectivesLearning Objectives

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When consolidated financial statements are prepared, asset and liability values must be adjusted by allocating the difference between implied and book values to specific recorded or unrecorded tangible and intangible assets and liabilities.

In the case of a wholly owned subsidiary, the implied value of the subsidiary equals the acquisition price.

Allocation of Difference Between Allocation of Difference Between ImpliedImpliedand Book Values: Acquisition Dateand Book Values: Acquisition Date

LO 1 Computation and Allocation of Difference.LO 1 Computation and Allocation of Difference.

Slide 5-4

Allocation of difference between implied and book values at date of acquisition - wholly owned subsidiary.

Step 1: Difference used first to adjust the individual assets and liabilities to their fair values on the date of acquisition.

Step 2: Any residual amount: Implied value > aggregate fair values = goodwill.

Implied value < aggregate fair values = bargain. Bargain is recognized as an ordinary gain.


LO 1 Computation and Allocation of Difference.LO 1 Computation and Allocation of Difference.

Slide 5-5

Bargain Rules under prior GAAP (before 2007 standard):

1. Acquired assets, except investments accounted for by the equity method, are recorded at fair market value.

2. Previously recorded goodwill is eliminated.

3. Long-lived assets (including in-process R&D and excluding long-term investments) are recorded at fair market value minus an adjustment for the bargain.

4. Extraordinary gain recorded if all long-lived assets are reduced to zero.• Current GAAP eliminates these rules and requires an

ordinary gain to be recognized instead.


LO 2 FASB’s position on accounting for bargain acquisitions.LO 2 FASB’s position on accounting for bargain acquisitions.

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Bargain Rules: When a bargain acquisition occurs, under FASB ASC paragraph 805-30-25-2, the negative (or credit) balance should be recognized as an ordinary gain in the year of acquisition. No assets should be recorded below their fair values.

Note: A true bargain is not likely to occur except in situations where nonquantitative factors play a role.


LO 2 FASB’s position on accounting for bargain acquisitions.LO 2 FASB’s position on accounting for bargain acquisitions.

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In the event of a bargain acquisition (after carefully considering the fair valuation of all subsidiary assets and liabilities) the FASB requires the following accounting:

a. an ordinary gain is reported in the financial statements of the consolidated entity.

b. an ordinary loss is reported in the financial statements of the consolidated entity.

c. negative goodwill is reported on the balance sheet.

d. assets are written down to zero value, if needed.

Review QuestionReview Question


LO 2 FASB’s position on accounting for bargain acquisitions.LO 2 FASB’s position on accounting for bargain acquisitions...

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E5-1:E5-1: On January 1, 2010, Pam Company purchased an 85% interest in Shaw Company for $540,000. On this date, Shaw Company had common stock of $400,000 and retained earnings of $140,000. An examination of Shaw Company’s assets and liabilities revealed that their book value was equal to their fair value except for marketable securities and equipment:

Book Value Fair Value Diff erenceMarketable securities 20,000$ 45,000$ 25,000$ Equipment 120,000 140,000 20,000

Allocation of DifferenceAllocation of Difference

Case 1: Implied Value “in Excess of” Fair Value

LO 4 Allocation of difference in a partially owned subsidiary.LO 4 Allocation of difference in a partially owned subsidiary.

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E5-1:E5-1: A. Prepare a Computation and Allocation Schedule for the difference between book value of equity acquired and the value implied by the purchase price.


85% 15% 100%Parent NCI TotalShare Share Value

Purchase price and implied value 540,000$ 95,294$ 635,294$ Book value of equity acquired:

Common stock 340,000 60,000 400,000 Retained earings 119,000 21,000 140,000 Total book value 459,000 81,000 540,000

Difference between implied and book value 81,000 14,294 95,294 Marketable securities (21,250) (3,750) (25,000) Equipment (17,000) (3,000) (20,000) Balance 42,750 7,544 50,294 Record new goodwill (42,750) (7,544) (50,294) Balance 0$ 0$ 0$

LO 4 CAD Schedule for less than wholly owned subsidiary.LO 4 CAD Schedule for less than wholly owned subsidiary.

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E5-1 (variation):E5-1 (variation): Prepare the worksheet entries to eliminate the investment, recognize the noncontrolling interest, and to allocate the difference between implied and book.


Common stock 400,000Retained earnings 140,000Difference between Implied and Book 95,294

Investment in Shaw

540,000Noncontrolling interest in Equity

95,294Marketable securities 25,000Equipment 20,000Goodwill 50,294

Difference between Implied and Book

95,294LO 4 Allocation of difference in a partially owned subsidiary.LO 4 Allocation of difference in a partially owned subsidiary.

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E5-1 (variation):E5-1 (variation): On January 1, 2010, Pam Company purchased an 85% interest in Shaw Company for $470,000. On this date, Shaw Company had common stock of $400,000 and retained earnings of $140,000. An examination of Shaw Company’s assets and liabilities revealed that their book value was equal to their fair value except for marketable securities and equipment:

Book Value Fair Value Diff erenceMarketable securities 20,000$ 45,000$ 25,000$ Equipment 120,000 140,000 20,000


Case 2: Acquisition Cost “Less Than” Fair Value


Slide 5-12





Difference between implied and book value 11,000 1,941 12,941 Marketable securities (21,250) (3,750) (25,000) Equipment (17,000) (3,000) (20,000) Balance (excess of FV over implied value) (27,250) (4,809) (32,059) Pam's gain 27,250 Increase noncontrolling interest to fair

value of assets 4,809 Total allocated gain 32,059 Balance 0 0 0

E5-1E5-1 (variation): (variation): Prepare a Computation and Allocation Schedule.


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E5-1E5-1 (variation):(variation): Prepare the worksheet entries.


Common stock 400,000Retained earnings 140,000Difference between Implied and Book 12,941

Investment in Shaw

470,000Noncontrolling interest in Equity

82,941Marketable securities 25,000Equipment 20,000

Gain on acquisition

27,250 Noncontrolling interest in equity

4,809 Difference between Implied and Book

12,941LO 4 Allocation of difference in a partially owned subsidiary.LO 4 Allocation of difference in a partially owned subsidiary.

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When any portion of the difference between implied and book values is allocated to depreciable and amortizable assets, recorded income must be adjusted in determining consolidated net income in current and future periods.

Adjustment is needed to reflect the difference between the amount of amortization and/or depreciation recorded by the subsidiary and the appropriate amount based on consolidated carrying values.

Effect of Allocation and Depreciation of Differences Effect of Allocation and Depreciation of Differences on Consolidated Net Income: Year Subsequent To on Consolidated Net Income: Year Subsequent To AcquisitionAcquisition


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P5-4:P5-4: On January 1, 2010, Porter Company purchased an 80% interest in Salem Company for $850,000. At that time, Salem Company had capital stock of $550,000 and retained earnings of $80,000. Differences between the fair value and the book value of the identifiable assets of Salem Company were as follows:

Fair Value in Excess of Book ValueEquipment 130,000$ Land 65,000 I nventory 40,000

Consolidated Statements – Cost Consolidated Statements – Cost MethodMethod

The book values of all other assets and liabilities of Salem Company were equal to their fair values on January 1, 2010. The equipment had a remaining life of five years. The inventory was sold in 2010.

LO 4 Allocation of difference in a partially owned subsidiary.LO 4 Allocation of difference in a partially owned subsidiary.Year of

Acquisition

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P5-4:P5-4: Salem Company’s net income and dividends declared in 2010 and 2011 were as follows: 2010 Net Income of $100,000; Dividends Declared of $25,000; 2011 Net Income of $110,000; Dividends Declared of $35,000.Entries recorded on the books of Porter to reflect the acquisition of Salem and the receipt of dividends for 2010 are as follows:


Investment in Salem 850,000Cash

850,000Cash 20,000

Dividend income ($25,000 x 80%) 20,000


Acquisition

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P5-4:P5-4: A. Prepare a Computation and Allocation Schedule



Purchase price and implied value 850,000$ 212,500$ 1,062,500$ Book value of equity acquired:


Difference between implied and book value 346,000 86,500 432,500 Equipment (104,000) (26,000) (130,000) Land (52,000) (13,000) (65,000) Inventory (32,000) (8,000) (40,000) Balance 158,000 39,500 197,500 Record new goodwill (158,000) (39,500) (197,500) Balance -$ -$ -$


Acquisition

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P5-4:P5-4: B. 1. Prepare the worksheet entries for Dec. 31, 2010.

Dividend income ($25,000 x 80%) 20,000Dividends declared

20,000Beg. retained earnings - Salem 80,000Common stock - Salem 550,000Difference between Cost and Book 432,500


Investment in Salem850,000


Noncontrolling interest in equity 212,500

Year of Acquisitio

n

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Cost of goods sold 40,000Land 65,000



Plant and equipment 130,000Goodwill 197,500

Difference between cost and book432,500

Depreciation expense ($130,000/5) 26,000Plant and equipment

26,000Year of

Acquisition

P5-4:P5-4: B. 1. Prepare the worksheet entries for Dec. 31, 2010.

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Investment in Salem 60,000Beg. Retained Earnings ‑ Porter Co.

60,000



Subsequent Year

Salem 2011 income $100,000Salem 2011 dividends declared - 25,000Total 75,000Ownership percentage 80%

$ 60,000

To establish reciprocity/convert to equity as of 1/1/2011

P5-4:P5-4: C. 1. Prepare the worksheet entries for Dec. 31, 2011.

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28,000

Beg. retained earnings - Salem 155,000Common stock - Salem 550,000Difference between Cost and Book 432,500





Subsequent Year


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Noncontrolling interest 8,000Land 65,000






52,000

1/1 Retained Earnings – Porter 32,000

Noncontrolling interest 5,2001/1 Retained Earnings – Porter 20,800

Subsequent Year


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P5-4:P5-4: D. Prepare a consolidated financial statements workpaper for the year ended December 31, 2012. Although no goodwill impairment was reflected at the end of 2010 or 2011, the goodwill impairment test conducted at December 31, 2012 revealed implied goodwill from Salem to be only $150,000. The impairment has not been recorded in the books of the parent. (Hint: You can infer the method being used by the parent from the information in its trial balance.)


LO 4 Allocation of difference in a partially owned subsidiary.LO 4 Allocation of difference in a partially owned subsidiary.Subseque

nt Year

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ConsolidatedIncome Statement Porter Salem Debit Credit NCI BalancesSales 1,100,000$ 450,000$ 1,550,000$ Dividend income 48,000 48,000

Total revenue 1,148,000 450,000 1,550,000 Cost of goods sold 900,000 200,000 1,100,000 Depreciation expense 40,000 30,000 26,000 96,000 Impairment loss 47,500 47,500 Other expenses 60,000 50,000 110,000

Total cost and expense 1,000,000 280,000 1,353,500 Net income 148,000 170,000 196,500 Noncontrolling interest 19,300 (19,300) Net income 148,000$ 170,000$ 121,500$ 19,300$ 177,200$

Retained Earnings StatementRetained earnings, 1/1/12 500,000 230,000 32,000 120,000 546,400

Porter 41,600 Salem 230,000

Net income 148,000 170,000 121,500 19,300 177,200 Dividends declared (90,000) (60,000) 48,000 (12,000) (90,000) Retained earnings, 12/31/12 558,000$ 340,000$ 425,100$ 168,000$ 7,300$ 633,600$

Eliminations

P5-4: D. 2012 Year Subsequent of Acquisition



Subsequent Year

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ConsolidatedIncome Statement Porter Salem Debit Credit NCI BalancesCash 70,000$ 65,000$ 135,000$ Accounts receivable 260,000 190,000 450,000 Inventory 240,000 175,000 415,000 Investment in Sid 850,000 120,000 970,000 Difference (IV & BV) 432,500 432,500 Land 320,000 65,000 385,000 Plant and equipment 360,000 280,000 130,000 78,000 692,000 Goodwill 197,500 47,500 150,000

Total assets 1,780,000$ 1,030,000$ 2,227,000$ -

Accounts payable 132,000$ 110,000$ 242,000$ Notes payable 90,000 30,000 120,000 Common stock 1,000,000 550,000 550,000 1,000,000 Retained earnings 558,000 340,000 425,100 168,000 7,300 633,600 1/1 NCI in net assets 8,000 242,500 224,100

10,400 12/31 NCI in net asset 231,400 231,400

Total liab. & equity 1,780,000$ 1,030,000$ 1,938,500$ 1,938,500$ 2,227,000$

Eliminations

LO 4 Allocation of difference in a partially owned subsidiary.LO 4 Allocation of difference in a partially owned subsidiary.Subseque

nt Year

P5-4: D. 2012 Year Subsequent of Acquisition


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Investment in Salem 120,000Beg. Retained Earnings ‑ Porter Co.

120,000



Subsequent Year

Acquisition date retained earnings - Salem $ 80,000Retained earnings 1/1/12 - Salem 230,000Increase 150,000Ownership percentage 80%

$ 120,000

To establish reciprocity/convert to equity as of 1/1/2012

P5-4:P5-4: D. Explanations of worksheet entries for Dec. 31, 2012.

Slide 5-27


48,000

Beg. retained earnings - Salem 230,000Common stock - Salem 550,000Difference between Cost and Book 432,500





Subsequent Year

P5-4P5-4 D. W Worksheet entries for Dec. 31, 2012.

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Noncontrolling interest 8,000Land 65,000





1/1 Retained Earnings – Porter 32,000

Subsequent Year


Slide 5-29 LO 4 Allocation of difference in a partially owned subsidiary.LO 4 Allocation of difference in a partially owned subsidiary.



78,000

Noncontrolling interest (2 years) 10,400 1/1 Retained Earnings – Porter (2 years) 41,600

Subsequent Year

Impairment loss ($197,500 - $150,000) 47,500Goodwill

47,500To record goodwill impairment


Slide 5-30 LO 5 Recording investment by Parent, complete equity LO 5 Recording investment by Parent, complete equity

method.method.

Consolidated Statements – Partial and Consolidated Statements – Partial and Complete Equity MethodsComplete Equity Methods

The equity methods (partial and complete) reflect the effects of certain transactions more fully than the cost method on the books of the parent. However consolidated totals are the same regardless of which method is used by the Parent company.

LO 5 Recording investment by Parent, partial equity method.LO 5 Recording investment by Parent, partial equity method.

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Notes payable, long-term debt, and other obligations of an acquired company should be valued for consolidation purposes at their fair values.

Fair value is the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value measurement assumes:

The liability is transferred to a market participant andThe nonperformance risk relating to the liability is the same before and after its transfer.

Additional Considerations Relating to Treatment Additional Considerations Relating to Treatment ofofDifference Between Implied and Book ValuesDifference Between Implied and Book ValuesAllocation of Difference between Implied and Book Values to Long-Term Debt

LO 7 Allocating difference to long-term debt.LO 7 Allocating difference to long-term debt.

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To measure fair value, use valuation techniques that are consistent with the market approach or income approach.

Quoted market prices are the best. If unavailable, then management’s best estimate based on

debt with similar characteristics or valuation techniques such as present value.

Additional Considerations Relating to Treatment Additional Considerations Relating to Treatment ofofDifference Between Implied and Book ValuesDifference Between Implied and Book ValuesAllocation of Difference between Implied and Book Values to Long-Term Debt

LO 7 Allocating difference to long-term debt.LO 7 Allocating difference to long-term debt.

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On the date of acquisition, sometimes the fair value of an asset is less than the amount

recorded on the books of the subsidiary. fair value of long-term debt may be greater rather

than less than its recorded value on the books of the subsidiary.

Additional Considerations Relating to Treatment Additional Considerations Relating to Treatment ofofDifference Between Implied and Book ValuesDifference Between Implied and Book ValuesAllocating the Difference to Assets (Liabilities) with Fair Values Less (Greater) Than Book Values

LO 8 Allocating when the fair value is below book value.LO 8 Allocating when the fair value is below book value.

Slide 5-34

E5-1E5-1 (Variation):(Variation): On January 1, 2010, Pam Company purchased an 85% interest in Shaw Company for $540,000. On this date, Shaw Company had common stock of $400,000 and retained earnings of $140,000. An examination of Shaw Company’s assets and liabilities revealed that their book value was equal to their fair value except for marketable securities and equipment: Book Value Fair Value Diff erenceMarketable securities 20,000$ 45,000$ 25,000$ Equipment (5 year life) 120,000 100,000 (20,000)

Allocating the Difference to Assets (Liabilities) with Fair Values Less (Greater) Than Book Values

Additional Considerations Relating to Treatment Additional Considerations Relating to Treatment ofofDifference Between Implied and Book ValuesDifference Between Implied and Book Values


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E5-1:E5-1: A. Prepare a Computation and Allocation Schedule for the difference between book value of equity acquired and the value implied by the purchase price.





Difference between implied and book value 81,000 14,294 95,294 Marketable securities (21,250) (3,750) (25,000) Equipment 17,000 3,000 20,000 Balance 76,750 13,544 90,294 Record new goodwill (76,750) (13,544) (90,294) Balance -$ -$ -$


Cost Method

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E5-1 (variation):E5-1 (variation): At the end of the firstfirst year, the workpaper entries are:


Marketable securities 25,000

Equipment20,000

Goodwill 90,294Difference between Implied and Book

95,294Equipment,net 4,000

Depreciation expense ($20,000 / 5 years)

4,000Note: the overvaluation of equipment will be amortized over the life of the asset as a reduction of depreciation expense.


Cost Method

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E5-1 (variation):E5-1 (variation): At the end of the secondsecond year, the workpaper entries are:


Marketable securities 25,000

Equipment20,000

Goodwill 90,294Difference between Implied and Book

95,294Equipment, net 8,000

Beg. retained earnings - Pam

3,400


Noncontrolling interest in equity

600Depreciation expense ($20,000 / 5 years)

4,000

Cost Method

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E5-7:E5-7: On January 1, 2011, Packard Company purchased an 80% interest in Sage Company for $600,000. On this date Sage Company had common stock of $150,000 and retained earnings of $400,000. Sage Company’s equipment on the date of Packard Company’s purchase had a book value of $400,000 and a fair value of $600,000. All equipment had an estimated useful life of 10 years on January 2, 2006.Required: Prepare the December 31 consolidated financial statements workpaper entries for 2011 and 2012, recording accumulated depreciation as a separate balance.

Reporting Accumulated Depreciation in Consolidated Financial Statements as a Separate Balance

LO 9 Depreciable assets at net and gross values.LO 9 Depreciable assets at net and gross values.


Slide 5-39

E5-7:E5-7: Prepare a Computation and Allocation Schedule.





Difference between implied and book value 160,000 40,000 200,000 Equipment (160,000) (40,000) (200,000) Balance -$ -$ -$


Slide 5-40

E5-7: E5-7: Prepare the December 31 consolidated financial statements workpaper entries for 2011 and 2012.


Equipment 400,000Accumulated depreciation

200,000Difference between Implied and Book

200,000Depreciation Expense ($200,000/5) 40,000

Accumulated Depreciation

40,000

Cost & Partial Equity Method


Slide 5-41

E5-7: E5-7: Prepare the December 31 consolidated financial statements workpaper entries for 2011 and 2012.


Equipment 400,000Accumulated depreciation

200,000Difference between Implied and Book

200,0001/1 Retained Earnings -Packard Co. 32,0001/1 Noncontrolling interest 8,000Depreciation Expense ($200,000/5) 40,000

Accumulated Depreciation

80,000


* Complete equity method: debit to 1/1 Retained Earnings – Packard Co. would be replaced with a debit to Investment in Sage Company

Cost & Partial Equity Method

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Disposal of Depreciable Assets by Subsidiary



In the year of sale, any gain or loss recognized by the subsidiary on the disposal of an asset to which any of the difference between implied and book value has been allocated must be adjusted in the consolidated statements workpaper.

Depreciable Assets Used in ManufacturingWhen the difference between implied and book values is allocated to depreciable assets used in manufacturing, workpaper entries may be more complex because the current and previous years additional depreciation may need to be allocated among work in process, finished goods, and cost of goods sold.

Slide 5-43 LO 10 Push down of accounting to the subsidiary’s books.LO 10 Push down of accounting to the subsidiary’s books.

Push Down AccountingPush Down Accounting

Push down accounting is the establishment of a new accounting and reporting basis for a subsidiary company in its separate financial statements based on the purchase price paid by the parent to acquire the controlling interest.

The valuation implied by the price of the stock to the parent company is “pushed down” to the subsidiary and used to restate its assets (including goodwill) and liabilities in its separate financial statements.



Arguments for and against Push Down AccountingThree important factors that should be considered in determining the appropriateness of push down accounting are:

1. Whether the subsidiary has outstanding debt held by the public.

2. Whether the subsidiary has outstanding a senior class of capital stock not acquired by the parent company.

3. The level at which a major change in ownership of an entity should be deemed to have occurred, for example, 100%, 90%, 51%.



Status of Push Down AccountingAs a general rule, the SEC requires push down accounting when the ownership change is greater than 95% and objects to push down accounting when the ownership change is less than 80%.

In addition, the SEC staff expresses the view that the existence of outstanding public debt, preferred stock, or a significant noncontrolling interest in a subsidiary might impact the parent company’s ability to control the form of ownership. In these circumstances, push down accounting, though not required, is an acceptable accounting method.

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