advanced accounting 6e by jeter chaney chapter 05

Advanced
Accounting
Jeter ● Chaney

Allocation and Depreciation
of Differences Between
Implied and Book Values

1

Prepared by Sheila Ammons, Austin Community College


Learning Objectives
• Calculate the difference between implied and book values and
allocate to the subsidiary’s assets and liabilities.
• Describe FASB’s position on accounting for bargain acquisitions.
• Explain how goodwill is measured at the time of the acquisition.
• Describe how the allocation process differs if less than 100% of the
subsidiary is acquired.
• 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.

Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Learning Objectives (continued)
• Prepare workpapers for the year of acquisition and the year(s)
subsequent to the acquisition, assuming that the parent accounts for
the investment alternatively using the cost, the partial equity, and the

complete equity methods.
• Understand the allocation of the difference between implied and book
values to long-term debt components.
• Explain how to allocate the difference between implied and book
values when some assets have fair values below book values.
• Distinguish between recording the subsidiary depreciable assets at net
versus gross fair values.
• Understand the concept of push down accounting.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Allocation of Difference Between Implied
and Book Values: Acquisition Date
• 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.

LO 1 Computation and Allocation of Difference (CAD).
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Allocation of Difference Between Implied
and Book Values: Acquisition Date
• Allocation of difference between implied and book values at
date of acquisition - wholly owned subsidiary (implied
value equals acquisition price).

• 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 (CAD).
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Allocation of Difference Between Implied
and Book Values: Acquisition Date
Bargain Rules under prior GAAP (before 2007 standard):
– Acquired assets, except investments accounted for by the equity
method, are recorded at fair market value.
– Previously recorded goodwill is eliminated.
– 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.
– 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 Current and past treatment of bargain acquisitions.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Allocation of Difference Between Implied
and Book Values: Acquisition Date
• 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.
• For example, a closely held company wishes to sell
quickly because of the health of a family member.

LO 2 Current and past treatment of bargain acquisitions.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Allocation of Difference Between Implied
and Book Values: Acquisition Date
Review Question
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.
LO 2 Current and past treatment of bargain acquisitions.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Allocation of Difference

Case 1: Implied Value “in Excess of” Fair Value
E5-1: On January 1, 2013, 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:

LO 1 Computation and Allocation of Difference (CAD).
LO 4 Allocation of difference in a partially owned subsidiary.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Allocation of Difference
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.

LO 4 CAD Schedule for less than wholly owned subsidiary.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Allocation of Difference
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 Value

95,294
Investment in Shaw
Noncontrolling Interest in Equity
540,000Securities
Marketable
Equipment
Goodwill
Difference between Implied and Book Value

25,000
95,294
20,000
50,294

LO 4 Allocation of difference in a partially owned subsidiary.

Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Allocation of Difference
Case 2: Acquisition Cost “Less Than” Fair Value
E5-1 (variation): On January 1, 2013, 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:

LO 4 Allocation of difference in a partially owned subsidiary.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.

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

LO 4 CAD Schedule for less than wholly owned subsidiary.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Allocation of Difference
E5-1 (variation): Prepare the worksheet entries.
Common Stock
Retained Earnings
Difference between Implied and Book Value
Investment in Shaw
Noncontrolling Interest in Equity
470,000Securities
Marketable
Equipment

400,000
140,000
12,941

25,000
82,941
20,000

Gain on Acquisition
Noncontrolling Interest in Equity

27,250
Difference between Implied and Book Value
4,809

LO 4 Allocation of difference in a partially owned subsidiary.

Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Effect of Differences Between Implied and Book
Values on Consolidated Net Income: Year
Subsequent To Acquisition
• 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.
LO 4 Allocation of difference in a partially owned subsidiary.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Consolidated Statements – Cost Method
P5-4: On January 1, 2013, 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:

The book values of all other assets and liabilities of Salem Company were
equal to their fair values on January 1, 2013. The equipment had a remaining
life of five years (on January 1, 2013). The inventory was sold in 2013.
LO 4 Allocation of difference in a partially owned subsidiary.
Year of
Acquisition

LO6 Workpaper entries (cost method).
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Consolidated Statements – Cost
Method
P5-4: Salem Company’s net income and dividends declared in 2013 and 2014
were as follows: 2013 Net Income of $100,000; Dividends Declared of $25,000;
2014 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 2013 are as follows:
Investment in Salem

850,000
Cash
850,000
20,000

Cash

Dividend

Income ($25,000 x 80%)
Year of
Acquisition

20,000
LO 5 Recording investment on books of Parent.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Consolidated Statements – Cost
Method
P5-4: A. Prepare a Computation and Allocation Schedule

Year of
Acquisition

LO 4 CAD Schedule for less than wholly owned subsidiary.
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Consolidated Statements – Cost
Method
P5-4: B. 1. Prepare the worksheet entries for Dec. 31, 2013.
Dividend Income ($25,000 x 80%)

20,000
Dividends

Declared
Beg. Retained Earnings - Salem

20,000
80,000

Common Stock - Salem

550,000

Difference between Cost and Book Value

432,500
Investment

in Salem
850,000

Noncontrolling Interest in Equity

212,500
Year of
Acquisition

LO 6 Workpaper entries (cost method).
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Consolidated Statements – Cost
Method
P5-4: B. 1. Prepare the worksheet entries for Dec. 31, 2013.
Cost of Goods Sold

40,000

Land

65,000

Plant and Equipment

130,000

Goodwill

197,500
Difference

between Cost and Book Value
432,500
26,000

Depreciation Expense ($130,000/5)

Plant and
Equipment
Year of
Acquisition

26,000
LO 6 Workpaper entries (cost method).
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.

Consolidated Statements – Cost
Method
P5-4: C. 1. Prepare the worksheet entries for Dec. 31, 2014.
Salem 2014 income
Salem 2014 dividends declared
Total
Ownership percentage

$100,000
- 25,000
75,000
80%
$ 60,000

Investment in Salem

60,000
Beg.

Retained Earnings ‑ Porter Co.

To establish reciprocity/convert to equity as of 1/1/2014
Subsequent
Year

60,000

LO 6 Workpaper entries (cost method).

Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Consolidated Statements – Cost
Method
P5-4: C. 1. Prepare the worksheet entries for Dec. 31, 2014.
Dividend Income ($35,000 x 80%)

28,000
Dividends

Declared
Beg. Retained Earnings - Salem

28,000
155,000

Common Stock - Salem

550,000

Difference between Cost and Book Value

432,500
Investment

in Salem
910,000

Noncontrolling Interest in Equity

227,500
Subsequent
Year

LO 6 Workpaper entries (cost method).
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Consolidated Statements – Cost
Method
P5-4: C. 1. Prepare the worksheet entries for Dec. 31, 2014.
1/1 Retained Earnings – Porter

32,000

Noncontrolling interest
Land

8,000
65,000

Plant and Equipment

130,000

Goodwill

197,500
Difference

between Cost and Book Value
1/1 Retained Earnings – Porter
Noncontrolling Interest

20,800
432,500
5,200

Depreciation Expense ($130,000/5)

26,000
Plant and

Equipment

Subsequent
Year

52,000
LO 6 Workpaper entries
(cost method).
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.


Consolidated Statements – Cost
Method
• P5-4: D. Prepare a consolidated financial statements
workpaper for the year ended December 31, 2015.
Although no goodwill impairment was reflected at the

end of 2013 or 2014, the goodwill impairment test
conducted at December 31, 2015 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 6 Workpaper entries (cost method).

Subsequent
Year
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Consolidated Statements – Cost Method
P5-4: D. 2015 Year Subsequent of Acquisition

Subsequent
Year

LO 6 Workpaper entries (cost method).
Copyright © 2015. John Wiley & Sons, Inc. All rights reserved.