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Advanced Accounting by Debra Jeter and Paul Chaney
Chapter 5: Allocation, Depreciation, and Amortization of the Difference between Cost
and Book Value
Slides Authored by Hannah Wong, Ph.D.Rutgers University
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Allocation of Purchase Differential
Book value of net assets acquired
Purchase differential
Acquisitioncost
(MV-BV) ofidentifiablenet assetsGoodwill
(if amount >0) or bargain purchase
(if amount <0)
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Allocation of Purchase Differential:An Alternative View
Book value of net assets acquired
Acquisitioncost
(MV-BV) ofidentifiablenet assets
Goodwill (if amount >0)
or bargain purchase (if amount <0)
Market value of net assets acquired
Goodwill (if amount >0)
or bargain purchase (if amount <0)
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Bargain Purchase
Valuation of Net Assets Acquired:
Current assets, long-term investments in marketable securities, liabilities = fair value
Previously recorded goodwill = 0
Long-term assets = fair value - bargain allocation
(The bargain is allocated to long-term assets in proportion to their fair value.)
Any remaining bargain is recorded as negative goodwill and amortized over a maximum of 40 years.
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Case 1: Positive Goodwill
Book value of net assets acquired
$2,000,000
Purchase differential$750,000
Acquisitioncost
$2,750,000
Goodwill $250,000
Inventory $50,000
Equipment $300,000
Land $150,000
Wholly Owned Subsidiary
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Case 1: Positive Goodwill
Book value of net assets acquired
$1,600,000
Purchase differential$600,000
Acquisitioncost
$2,200,000
80% Owned Subsidiary
Goodwill $200,000
Inventory $40,000
Equipment $240,000
Land $120,000
Note: identifiable net assets are written up
only by :
P% x (MV-BV)
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Case 1: Positive Goodwill - EE’s
Retained earnings - S 400,000
Capital stock - S 1,200,000
Difference between cost and book value 600,000
Investment in S 2,200,000
The Investment Entry
The Allocation EntryInventory 40,000
Equipment 240,000
Land 120,000
Goodwill 200,000
Difference between cost and book value 600,000
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Case 2A: Bargain PurchaseBV < Cost
Book value of net assets acquired
$1,600,000
Purchase differential$300,000
Acquisitioncost
$1,900,000
80% Owned Subsidiary
Inventory $40,000
Equipment $240,000
Land $120,000
Note: identifiable net assets are written up
only by :
P% x (MV-BV)
Bargain purchase $100,000
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Case 2A: Bargain PurchaseBV < Cost
Bargain purchase $100,000
Allocation of Bargain Purchase
Note: assets are reduced in proportion to their fair values, not book values
Equipment $30,000
Land $20,000
Other noncurrentassets $50,000
Reduction in asset amounts:
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Case 2A: Bargain PurchaseBV < Cost : EE’s
Retained earnings - S 400,000
Capital stock - S 1,200,000
Difference between cost and book value 300,000
Investment in S 1,900,000
The Investment Entry
The Allocation EntryInventory 40,000
Equipment (240,000-30,000) 210,000
Land (120,000-20,000) 100,000
Other noncurrent assets (0-50,000) 50,000
Difference between cost and book value 300,000
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Case 2B: Bargain PurchaseBV > Cost
Book value of net assets acquired
$1,600,000
Purchase differential-$100,000
Acquisitioncost
$1,500,000
80% Owned Subsidiary
Bargain purchase $500,000
Inventory $40,000
Equipment $240,000
Land $120,000
Note: identifiable net assets are written up
only by :
P% x (MV-BV)
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Case 2B: Bargain PurchaseBV > Cost
Bargain purchase $500,000
Allocation of Bargain Purchase
Note: assets are reduced in proportion to their fair values, not book values
Equipment $150,000
Land $100,000
Other noncurrentassets $250,000
Reduction in asset amounts:
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Case 2B: Bargain PurchaseBV > Cost : EE’s
Retained earnings - S 400,000
Capital stock - S 1,200,000
Difference between cost and book value 100,000
Investment in S 1,500,000
The Investment Entry
The Allocation Entry
Difference between cost and book value 100,000
Inventory 40,000
Equipment (240,000-150,000) 90,000
Land (120,000-100,000) 20,000
Other noncurrent assets (0-250,000) 250,000
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Amortization of Purchase Differential
Case 1: Positive Goodwill, 80% Owned Subsidiary
Goodwill $200,000
Equipment $240,000
Land $120,000
Inventory $40,000Inventory $40,000Inventory $40,000Inventory $40,000Inventory $40,000Inventory $40,000Inventory $40,000COGS $40,000
Depreciation expense$24,000
Depreciation expense $24,000
Amortization expense $10,000
Amortization expense $10,000
Amortization expense$10,000
Purchase differential
Annual adjustments to consolidated NI
2001 2002-2010 2011-2020
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Amortization of Purchase Differential
Case 1: Positive Goodwill, 80% Owned Subsidiary
COGS $40,000
Depreciation expense$24,000
Depreciation expense $24,000
Amortization expense $10,000
Amortization expense $10,000
Annual adjustments to beginning consolidated R/E
2001 2001
ConsolidatedNI
adjustments
Depreciation expense $24,000
Amortization expense $10,000
2002
Adjustmentsto 1/1 R/E
= sum of NI adjustments in
all previous years
74,0000 108,000
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The Allocation EE Cost Method
Cost of goods sold 40,000
Depreciation expense 24,000
Amortization expense of goodwill 10,000
Equipment 216,000
Land 120,000
Goodwill 190,000
Difference between cost and book value 600,000
Add up to $74,000, becomes the 1/1 R/E adjustment in the next year(see next slide)
End of Year of Acquisition
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The Allocation EE Cost Method
Year Subsequent to Acquisition
Beginning retained earnings 74,000
Depreciation expense 24,000
Amortization expense of goodwill 10,000
Equipment 192,000
Land 120,000
Goodwill 180,000
Difference between cost and book value 600,000
Add up to $108,000, becomes the 1/1 R/E adjustment in the next year(see next slide)
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The Allocation EE Cost Method
2 Years Subsequent to Acquisition
Beginning retained earnings 108,000
Depreciation expense 24,000
Amortization expense of goodwill 10,000
Equipment 168,000
Land 120,000
Goodwill 170,000
Difference between cost and book value 600,000
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The Allocation EE Partial Equity Method
Cost of goods sold 40,000
Depreciation expense 24,000
Amortization expense of goodwill 10,000
Equipment 216,000
Land 120,000
Goodwill 190,000
Difference between cost and book value 600,000
Add up to $74,000, becomes the 1/1 R/E adjustment in the next year(see next slide)
End of Year of Acquisition
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The Allocation EE Partial Equity Method
Year Subsequent to Acquisition
Beginning retained earnings 74,000
Depreciation expense 24,000
Amortization expense of goodwill 10,000
Equipment 192,000
Land 120,000
Goodwill 180,000
Difference between cost and book value 600,000
Add up to $108,000, becomes the 1/1 R/E adjustment in the next year(see next slide)
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The Allocation EE Complete Equity Method
Cost of goods sold 40,000
Depreciation expense 24,000
Amortization expense of goodwill 10,000
Equipment 216,000
Land 120,000
Goodwill 190,000
Difference between cost and book value 600,000
Add up to $74,000, becomes the 1/1 R/E adjustment in the next year(see next slide)
End of Year of Acquisition
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The Allocation EE Complete Equity Method
Year Subsequent to Acquisition
Investment in S 74,000
Depreciation expense 24,000
Amortization expense of goodwill 10,000
Equipment 192,000
Land 120,000
Goodwill 180,000
Difference between cost and book value 600,000
Add up to $108,000, becomes the 1/1 R/E adjustment in the next year(see next slide)
Note: The investment account, instead of the beginning R/E, is adjusted under the complete equity method
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Push Down Accounting
Definition A subsidiary changes the accounting
basis in its separate financial statements based on the purchase price paid by the parent for its stock.
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Push Down Accounting
S has outstanding public debt?
Push down accounting should
not be used
Yes
No
S has outstanding senior class of capital stock?
What is P’s % of ownership?
<80%
Yes
No
80-95%
<80%
Push down accounting isrecommended
Push down accounting is
required
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Advanced Accounting
by
Debra Jeter and Paul Chaney
Copyright © 2001 John Wiley & Sons, Inc. All rights reserved.Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.
