Advanced accounting, 5th edition international student version ch05

55
Allocation and Depreciation of
Differences Between Implied and
Book Values Acquisition

Advanced Accounting, Fifth Edition
Slide
5-1


Learning
Learning Objectives
Objectives

Slide
5-2

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.


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

Slide
5-3

LO 1 Computation and Allocation of Difference.


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

Slide
5-4

LO 1 Computation and Allocation of Difference.


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

•
Slide
5-5

Current GAAP eliminates these rules and requires an
ordinary
gain to
be recognized
instead.
LO 2 FASB’s
position
on accounting
for bargain acquisitions.


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

Slide
5-6

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


Allocation
Allocation of
of Difference
Difference Between
Between
Implied
Implied
and
and Book
Book Values:
Values: Acquisition
Acquisition Date
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.
Slide
5-7

LO 2are
FASB’s
position
on accounting
for bargain
acquisitions.
d. assets
written
down
to zero value,
if needed.


Allocation
Allocation of
of Difference
Difference
Case 1: Implied Value “in Excess of” Fair Value
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:
Marketable securities
Equipment

Slide
5-8

Book Value
$ 20,000
120,000

Fair Value
$ 45,000
140,000

Diff erence
$ 25,000
20,000

LO 4 Allocation of difference in a partially owned subsidiary.


Allocation
Allocation of
of Difference
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.

Purchase price and implied value
Book value of equity acquired:
Common stock
Retained earings
Total book value
Difference between implied and book value
Marketable securities
Equipment
Balance
Record new goodwill
Balance
Slide
5-9

85%
Parent
Share
$ 540,000
340,000
119,000
459,000
81,000
(21,250)
(17,000)
42,750
(42,750)
$

0

15%
NCI
Share
$ 95,294

$

60,000
21,000
81,000
14,294
(3,750)
(3,000)
7,544
(7,544)
0

100%
Total
Value
$ 635,294
400,000
140,000
540,000
95,294
(25,000)
(20,000)
50,294

(50,294)
$
0

LO 4 CAD Schedule for less than wholly owned subsidiary.


Allocation
Allocation of
of Difference
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 95,294
Investment in Shaw
Noncontrolling interest in Equity
Marketable securities

25,000

Equipment
20,000
Goodwill
50,294
Difference between Implied and Book

Slide
5-10

540,000
95,294

95,294

LO 4 Allocation of difference in a partially owned subsidiary.


Allocation
Allocation of
of Difference
Difference
Case 2: Acquisition Cost “Less Than” Fair Value
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:
Marketable securities
Equipment

Slide
5-11

Book Value

$ 20,000
120,000

Fair Value
$ 45,000
140,000

Diff erence
$ 25,000
20,000

LO 4 Allocation of difference in a partially owned subsidiary.


Allocation
Allocation of
of Difference
Difference
E5-1 (variation): Prepare a
Computation and Allocation
Schedule.
Purchase price and implied value
Book value of equity acquired:
Common stock
Retained earings
Total book value
Difference between implied and book value
Marketable securities
Equipment
Balance (excess of FV over implied value)

Pam's gain
Increase noncontrolling interest to fair
value of assets
Total allocated gain
Balance
Slide
5-12

85%
Parent
Share
$ 470,000
340,000
119,000
459,000
11,000
(21,250)
(17,000)
(27,250)
27,250

15%
NCI
Share
$ 82,941
60,000
21,000
81,000
1,941
(3,750)

(3,000)
(4,809)

100%
Total
Value
$ 552,941
400,000
140,000
540,000
12,941
(25,000)
(20,000)
(32,059)

4,809
0

0

32,059
0

LO 4 Allocation of difference in a partially owned subsidiary.


Allocation
Allocation of
of Difference
Difference

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

400,000

Retained earnings
140,000
Difference between Implied and Book 12,941
Investment in Shaw
Noncontrolling interest in Equity
Marketable securities
Equipment

82,941
25,000
20,000

Gain on acquisition
Noncontrolling interest in equity
Difference between Implied and Book
Slide
5-13

470,000

27,250
4,809
12,941

LO 4 Allocation of difference in a partially owned subsidiary.

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

Slide
5-14

LO 4 Allocation of difference in a partially owned subsidiary.


Consolidated
Consolidated Statements
Statements –– Cost
Cost
Method
Method
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:
Equipment
Land
I nventory

Fair Value in Excess of Book Value
$ 130,000
65,000
40,000

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.
Slide
5-15

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


Consolidated
Consolidated Statements
Statements –– Cost
Cost
Method
Method
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

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

Slide
5-16

850,000
20,000
20,000

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


Consolidated
Consolidated Statements
Statements –– Cost
Cost
Method
Method

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

Purchase price and implied value
Book value of equity acquired:
Common stock
Retained earings
Total book value
Difference between implied and book value
Equipment
Land

Inventory
Balance
Record new goodwill
Balance

Slide
5-17

80%
Parent
Share
$ 850,000

20%
NCI
Share
$ 212,500

100%
Total
Value
$ 1,062,500

440,000
64,000
504,000
346,000
(104,000)
(52,000)
(32,000)

158,000
(158,000)
$
-

110,000
16,000
126,000
86,500
(26,000)
(13,000)
(8,000)
39,500
(39,500)
$
-

550,000
80,000
630,000
432,500
(130,000)
(65,000)
(40,000)
197,500
(197,500)
$
-

Year of

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


Consolidated
Consolidated Statements
Statements –– Cost
Cost
Method
Method

P5-4: B. 1. Prepare the worksheet entries for Dec. 31,
2010.
Dividend income ($25,000 x 80%)

20,000

Dividends declared
Beg. retained earnings - Salem

Slide
5-18

20,000
80,000

Common stock - Salem

550,000

Difference between Cost and Book

432,500

Investment in Salem

850,000

Noncontrolling interest in equity

212,500

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


Consolidated
Consolidated Statements
Statements –– Cost
Cost
Method
Method

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

40,000

Land

65,000

Plant and equipment

130,000

Goodwill

197,500

Difference between cost and book

Depreciation expense ($130,000/5)
Plant and equipment
Slide
5-19

432,500

26,000
26,000

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

Consolidated
Consolidated Statements
Statements –– Cost
Cost
Method
Method

P5-4: C. 1. Prepare the worksheet entries for Dec. 31,
2011.
Salem 2011 income
Salem 2011 dividends declared
Total

$100,000
- 25,000
75,000

Ownership percentage

80%
$ 60,000

Investment in Salem

60,000

Beg. Retained Earnings ‑ Porter Co.

60,000

To establish reciprocity/convert to equity as of
1/1/2011
Slide
5-20

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


Consolidated
Consolidated Statements
Statements –– Cost
Cost
Method
Method

P5-4: C. 1. Prepare the worksheet entries for Dec. 31,
2011.
Dividend income ($35,000 x 80%)

28,000

Dividends declared

Slide
5-21

28,000

Beg. retained earnings - Salem

155,000

Common stock - Salem

550,000

Difference between Cost and Book

432,500

Investment in Salem

910,000

Noncontrolling interest in equity

227,500

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


Consolidated
Consolidated Statements
Statements –– Cost

Cost
Method
Method

P5-4: C. 1. Prepare the worksheet entries for Dec. 31,
2011.
1/1 Retained Earnings – Porter

32,000

Noncontrolling interest
Land

8,000
65,000

Plant and equipment
Goodwill

130,000
197,500

Difference between cost and book
1/1 Retained Earnings – Porter
Noncontrolling interest

20,800
5,200

Depreciation expense ($130,000/5)

26,000

Plant and equipment
Slide
5-22

432,500

52,000

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


Consolidated
Consolidated Statements
Statements –– Cost
Cost
Method
Method

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.)

Slide
5-23

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


Consolidated
Consolidated Statements
Statements –– Cost
Cost
Method
Method

P5-4: D. 2012

Slide
5-24

Year Subsequent of Acquisition

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

Consolidated
Consolidated Statements
Statements –– Cost
Cost
Method
Method

P5-4: D. 2012
Income Statement
Cash
Accounts receivable
Inventory
Investment in Sid
Difference (IV & BV)
Land
Plant and equipment
Goodwill
Total assets
Accounts payable
Notes payable
Common stock
Retained earnings
1/1 NCI in net assets

$

Porter
70,000
260,000
240,000

850,000

$

Eliminations
Debit
Credit

Salem
65,000
190,000
175,000

120,000
432,500
65,000
130,000
197,500

320,000
280,000

360,000

NCI

Consolidated
Balances
$
135,000

450,000
415,000

970,000
432,500
78,000
47,500

$

1,780,000

$

1,030,000

$

$

132,000
90,000
1,000,000
558,000

$

110,000
30,000
550,000

340,000

$

12/31 NCI in net asset
Total liab. & equity $

Slide
5-25

Year Subsequent of Acquisition

550,000
425,100
8,000
10,400

168,000
242,500

7,300
224,100
231,400

1,780,000

$

1,030,000

$

1,938,500

$ 1,938,500

$

385,000
692,000
150,000
2,227,000
242,000
120,000
1,000,000
633,600

231,400
2,227,000

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