allocation and depreciation of differences between implied and book values acquisition advanced...

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

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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 ObjectivesLearning ObjectivesLearning Objectives

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.

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.

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.

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.




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




..

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 erence

Marketable securities 20,000$ 45,000$ 25,000$ Equipment 120,000 140,000 20,000

Allocation of DifferenceAllocation of DifferenceAllocation 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.

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.

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 400,000

Retained earnings 140,000

Difference between Implied and Book 95,294

Investment in Shaw

540,000Noncontrolling interest in Equity

95,294Marketable securities 25,000

Equipment 20,000

Goodwill 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.

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 erence

Marketable securities 20,000$ 45,000$ 25,000$ Equipment 120,000 140,000 20,000


Case 2: Acquisition Cost “Less Than” Fair Value






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.


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


Common stock 400,000

Retained earnings 140,000

Difference between Implied and Book 12,941

Investment in Shaw

470,000Noncontrolling interest in Equity

82,941Marketable securities 25,000

Equipment 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.

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

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


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 MethodMethodConsolidated 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

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 850,000

Cash850,000

Cash 20,000

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


Acquisition

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

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


Dividends declared20,000

Beg. retained earnings - Salem 80,000

Common stock - Salem 550,000

Difference between Cost and Book 432,500


Investment in Salem850,000


Noncontrolling interest in equity 212,500

Year of Acquisitio

n

Cost of goods sold 40,000

Land 65,000



Plant and equipment 130,000

Goodwill 197,500

Difference between cost and book432,500

Depreciation expense ($130,000/5) 26,000

Plant and equipment26,000

Year of Acquisitio

n

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


Beg. Retained Earnings ‑ Porter Co. 60,000



Subsequent Year

Salem 2011 income $100,000

Salem 2011 dividends declared - 25,000

Total 75,000

Ownership 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.










Subsequent Year


Noncontrolling interest 8,000

Land 65,000




Goodwill 197,500




1/1 Retained Earnings – Porter 32,000



Subsequent Year


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

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

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



Beg. Retained Earnings ‑ Porter Co. 120,000



Subsequent Year

Acquisition date retained earnings - Salem $ 80,000

Retained earnings 1/1/12 - Salem 230,000

Increase 150,000

Ownership 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.










Subsequent Year

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


Land 65,000




Goodwill 197,500



Subsequent Year






Noncontrolling interest (2 years) 10,400

1/1 Retained Earnings – Porter (2 years) 41,600

Subsequent Year

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

Goodwill47,500To record goodwill impairment


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 MethodsConsolidated 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.

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 and

The 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 Values


Allocation 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.

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.



Allocation 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.

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.



Allocating 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.

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




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

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


Marketable securities 25,000

Equipment20,000

Goodwill 90,294


95,294

Equipment,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

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


Marketable securities 25,000

Equipment20,000

Goodwill 90,294


95,294

Equipment, net 8,000

Beg. retained earnings - Pam

3,400


Noncontrolling interest in equity

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

4,000

Cost Method

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.


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 -$ -$ -$


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


Equipment 400,000

Accumulated depreciation

200,000Difference between Implied and Book

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

Accumulated Depreciation

40,000

Cost & Partial Equity Method


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


Equipment 400,000

Accumulated depreciation

200,000Difference between Implied and Book

200,0001/1 Retained Earnings -Packard Co. 32,000

1/1 Noncontrolling interest 8,000

Depreciation 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

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 Manufacturing

When 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.

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 AccountingPush 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 Accounting

As 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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