advanced accounting 6e by jeter chaney chapter 05

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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.

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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.

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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

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LO 1 Computation and Allocation of Difference (CAD).

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• 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

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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

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LO 2 Current and past treatment of 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.

• For example, a closely held company wishes to sell quickly because of the health of a family member.

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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.

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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:

Allocation of Difference9

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

LO 4 Allocation of difference in a partially owned subsidiary.

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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.

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

Difference between Implied and Book Value 95,294

Investment in Shaw 540,000

Noncontrolling Interest in Equity

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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:

Case 2: Acquisition Cost “Less Than” Fair Value

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E5-1 (variation): Prepare a

Computation and Allocation Schedule

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E5-1 (variation): Prepare the worksheet entries

Investment in Shaw 470,000

Noncontrolling Interest in Equity

82,941

Gain on Acquisition 27,250

Noncontrolling Interest in Equity 4,809

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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.

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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:

Consolidated Statements – Cost Method16

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

LO6 Workpaper entries (cost method).

Year of Acquisition

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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:

Consolidated Statements – Cost Method

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Cash850,000

Dividend Income ($25,000 x 80%)

20,000

LO 5 Recording investment on books of Parent.

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P5-4: A Prepare a Computation and Allocation Schedule

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P5-4: B 1 Prepare the worksheet entries for Dec 31, 2013 Dividend Income ($25,000 x 80%) 20,000

Dividends Declared

20,000

Difference between Cost and Book Value 432,500

LO 6 Workpaper entries (cost method).

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Difference between Cost and Book Value

432,500Depreciation Expense ($130,000/5) 26,000

Plant and Equipment

26,000

P5-4: B 1 Prepare the worksheet entries for Dec 31, 2013.

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Investment in Salem 60,000

Beg

Retained Earnings Porter Co.‑

60,000

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Subsequent Year

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

P5-4: C 1 Prepare the worksheet entries for Dec 31, 2014.

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Dividend Income ($35,000 x 80%) 28,000

Dividends Declared

28,000

Difference between Cost and Book Value 432,500

P5-4: C 1 Prepare the worksheet entries for Dec 31, 2014

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Noncontrolling interest 8,000

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432,500

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

Plant and Equipment

P5-4: C 1 Prepare the worksheet entries for Dec 31, 2014.

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• 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.)

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Subsequent Year

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P5-4: D 2015 Year Subsequent of Acquisition

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Subsequent

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Subsequent Year

P5-4: D 2015 Year Subsequent of Acquisition

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Beg

Retained Earnings Porter Co.‑

120,000

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Subsequent Year

Acquisition date retained earnings - Salem

$ 80,000Retained earnings 1/1/15 - Salem230,000

Increase150,000Ownership percentage80%

$ 120,000

To establish reciprocity/convert to equity as of 1/1/2015

P5-4: D Explanations of worksheet entries for Dec 31, 2015.

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Dividend Income ($60,000 x 80%) 48,000

Dividends Declared

48,000

Difference between Cost and Book Value 432,500

Year

P5-4 D Worksheet entries for Dec 31, 2015.

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Noncontrolling Interest 8,000

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432,500

Subsequent Year

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Plant and Equipment

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) 47,500

Goodwill

47,500

To record goodwill impairment

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LO 5 Recording investment by Parent, complete equity method.

Consolidated Statements – Partial and Complete 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.

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LO 5 Recording investment by Parent, partial equity method.

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Additional Considerations Relating to Treatment

of Difference Between Implied and Book Values

Allocation of Difference between Implied and Book Values to Term Debt

Long-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 at the measurement date and

• The nonperformance risk relating to the liability is the same before and after its transfer.

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LO 7 Allocating difference to long-term debt.

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Allocation of Difference between Implied and Book Values to Long-Term Debt

– To measure fair value, use valuation techniques that are consistent with the market approach or income approach – Quoted prices in active markets for identical liabilities are the best If unavailable, then management’s best estimate based on

• debt with comparable characteristics or

• valuation techniques such as present value

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LO 7 Allocating difference to long-term debt.

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

• 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.

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

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