chapter 5 advanced accounting

Differences Between Implied andDifferences Between Implied and
Book Values AcquisitionBook Values Acquisition
Advanced Accounting, Fifth Edition
Slide
5-3
1. Calculate the difference between implied and book values and allocate to the subsidiary’s assets and liabilities.
2. Describe FAS’s position on accountin! for bar!ain ac"uisitions.
#. $%plain how !oodwill is measured at the time of the ac"uisition.
&. Describe how the allocation process differs if less than 1''( of the subsidiary is ac"uired.
). *ecord the entries needed on the parent’s books to account for the investment under the three methods+ the cost, the partial e"uity, and the complete e"uity methods.
-. repare workpapers for the year of ac"uisition and the year/s0 subse"uent to the ac"uisition, assumin! that the parent accounts for the investment usin! the cost, the partial e"uity, and the complete e"uity methods.
. nderstand the allocation of the difference between implied and book values to lon!3 term debt components.
4. $%plain how to allocate the difference between implied and book values when some assets have fair values below book values.
5. Distin!uish between recordin! the subsidiary depreciable assets at net versus !ross fair values.
1'. nderstand the concept of push down accountin!.
Learning Objectives Learning Objectives
and liability values must be ad7usted by allocatin! the
difference between implied and book values to specific
recorded or unrecorded tan!ible and intan!ible assets and
liabilities.
8n the case of a wholly owned subsidiary, the implied value
of the subsidiary e"uals the ac"uisition price.
Allocation of Difference Between Implied Allocation of Difference Between Implied and Book Values Ac!uisition Date and Book Values Ac!uisition Date

date of ac"uisition 3 wholly owned subsidiary.
%tep "+ Difference used first to ad7ust the individual assets and
liabilities to their fair values on the date of ac"uisition.
%tep &+ Any residual amount+
8mplied value ; a!!re!ate fair values : bargain. ar!ain is
reco!ni<ed as an ordinary !ain.

Bargain 'ules under prior (AA) /before 2'' standard0+
1. Ac"uired assets, e%cept investments accounted for by the e"uity
method, are recorded at fair market value.
2. reviously recorded !oodwill is eliminated.
#. =on!3lived assets /includin! in3process *>D and e%cludin! lon!3term
investments0 are recorded at fair market value minus an
ad7ustment for the bar!ain.
&. $%traordinary !ain recorded if all lon!3lived assets are reduced to
<ero.
!ain to be reco!ni<ed instead.


FAS ASC para!raph 4')3#'32)32, the ne!ative /or credit0
balance should be reco!ni<ed as an ordinary !ain in the year
of ac"uisition. ?o assets should be recorded below their
fair values.
?ote+ A true bar!ain is not likely to occur e%cept in
situations where non"uantitative factors play a role.


Slide
5-8
8n the event of a bar!ain ac"uisition /after carefully considerin! the fair valuation of all subsidiary assets and liabilities0 the FAS re"uires the followin! accountin!+
a. an ordinary !ain 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. ne!ative !oodwill is reported on the balance sheet.
d. assets are written down to <ero value, if needed.
'eview ,uestion'eview ,uestion


interest in Shaw Company for B)&','''. @n this date, Shaw
Company had common stock of B&'',''' and retained earnin!s of
B1&','''. An e%amination of Shaw Company’s assets and liabilities
revealed that their book value was e"ual to their fair value e%cept
for marketable securities and e"uipment+
ook Calue Fair Calue Difference
Darketable securities 2','''B &),'''B 2),'''B
$"uipment 12',''' 1&',''' 2','''

#ase " Implied Value 0in -1cess of2 *air Value

difference between book value of e"uity ac"uired and the value
implied by the purchase price.
Allocation of Difference Allocation of Difference

85 15 100
oo value of e.uit/ ac.ui"ed
$o**on (toc 340,000 60,000 400,000
etained ea"ing( 119,000 21,000 140,000
&otal oo value 459,000 81,000 540,000
iffe"ence eteen i*)lied and oo value 81,000 14,294 95,294
a"etale (ecu"itie( 21,250 3,750 25,000
E.ui)*ent 17,000 3,000 20,000
alance 42,750 7,544 50,294
alance 0+ 0+ 0+

the difference between implied and book.

Common stock &'','''
8nvestment in Shaw )&','''
arketable securities 2),'''
Difference between 8mplied and ook 5),25&

-./" 4variation5-./" 4variation5 @n anuary 1, 2'1', am Company purchased an
4)( interest in Shaw Company for B&','''. @n this date, Shaw
$"uipment 12',''' 1&',''' 2','''

#ase & Ac!uisition #ost 0Less 6han2 *air Value

85 15 100
$o**on (toc 340,000 60,000 400,000
etained ea"ing( 119,000 21,000 140,000
&otal oo value 459,000 81,000 540,000
a"etale (ecu"itie( 21,250 3,750 25,000
E.ui)*ent 17,000 3,000 20,000
alance ece(( of F' ove" i*)lied value 27,250 4,809 32,059
!a*( gain 27,250
value of a((et( 4,809
&otal allocated gain 32,059
alance 0 0 0
-./"-./" 4variation54variation5 repare a Computation and Allocation Schedule.

Common stock &'','''
8nvestment in Shaw &','''
Difference between 8mplied and ook 12,5&1

assets, recorded income must be adjusted in determinin!
consolidated net income in current and future periods.
Adjustment is needed to reflect the difference between
the amount of amorti<ation andor depreciation recorded by
the subsidiary and the appropriate amount based on
consolidated carryin! values.

-ffect of Allocation and Depreciation of Differences on-ffect of Allocation and Depreciation of Differences on #onsolidated 7et Income 8ear %ubse!uent 6o Ac!uisition #onsolidated 7et Income 8ear %ubse!uent 6o Ac!uisition

Slide
5-16
)./3)./3 @n anuary 1, 2'1', orter Company purchased an 4'( interest in Salem Company for B4)','''. At that time, Salem Company had capital stock of B))',''' and retained earnin!s of B4','''. Differences between the fair value and the book value of the identifiable assets of Salem Company were as follows+
Fair Calue in $%cess of ook Calue
$"uipment 1#','''B

#onsolidated %tatements 9 #ost :ethod #onsolidated %tatements 9 #ost :ethod
Ghe book values of all other assets and liabilities of Salem Company were e"ual to their fair values on anuary 1, 2'1'. Ghe e"uipment had a remainin! life of five years. Ghe inventory was sold in 2'1'.

Slide
5-17
)./3)./3 Salem Company’s net income and dividends declared in 2'1' and 2'11 were as follows+ 2'1' ?et 8ncome of B1'','''H Dividends Declared of B2),'''H 2'11 ?et 8ncome of B11','''H Dividends Declared of B#),'''.
$ntries recorded on the books of orter to reflect the ac"uisition of Salem and the receipt of dividends for 2'1' are as follows+

8nvestment in Salem 4)','''
Dividend income /B2),''' % 4'(0 2','''

80 20 100
$o**on (toc 440,000 110,000 550,000
etained ea"ing( 64,000 16,000 80,000
&otal oo value 504,000 126,000 630,000
E.ui)*ent 104,000 26,000 130,000
:and 52,000 13,000 65,000
%nvento"/ 32,000 8,000 40,000
alance 158,000 39,500 197,500
alance -+ -+ -+

Slide
5-19
)./3)./3 B$ "$ repare the worksheet entries for Dec. #1, 2'1'.
Dividend income /B2),''' % 4'(0 2','''
Dividends declared 2','''
Common stock 3 Salem ))','''
Difference between Cost and ook &#2,)''
LO 3 Allocation of difference in a partially owned subsidiary$LO 3 Allocation of difference in a partially owned subsidiary$
8nvestment in Salem 4)','''

?oncontrollin! interest in e"uity 212,)''
8ear of Ac!uisition
=and -),'''

lant and e"uipment 1#','''
lant and e"uipment 2-,'''
8ear of Ac!uisition

e!. *etained $arnin!s orter Co. -','''

%ubse!uent 8ear
Gotal ),'''
B -','''
Go establish reciprocityconvert to e"uity as of 112'11

Dividends declared 24,'''
Common stock 3 Salem ))','''
Difference between Cost and ook &#2,)''
8nvestment in Salem 51','''

?oncontrollin! interest in e"uity 22,)''
%ubse!uent 8ear

=and -),'''

lant and e"uipment 1#','''
lant and e"uipment )2,'''
?oncontrollin! interest ),2''
%ubse!uent 8ear

workpaper for the year ended December #1, 2'12. Althou!h
no !oodwill impairment was reflected at the end of 2'1' or
2'11, the !oodwill impairment test conducted at December #1,
2'12 revealed implied !oodwill from Salem to be only
B1)','''. Ghe impairment has not been recorded in the books
of the parent. /Jint+ Kou can infer the method bein! used by
the parent from the information in its trial balance.0

LO 3 Allocation of difference in a partially owned subsidiary$LO 3 Allocation of difference in a partially owned subsidiary$ %ubse!uent
8ear
)./3 D$ &;"& 8ear %ubse!uent of Ac!uisition

%ubse!uent 8ear
%nco*e State*ent !o"te" Sale* eit $"edit #$% alance(
$a(h 70,000+ 65,000+ 135,000+
%nvento"/ 240,000 175,000 415,000
iffe"ence %' ; ' 432,500 432,500
<oodill 197,500 47,500 150,000
&otal a((et( 1,780,000+ 1,030,000+ 2,227,000+
-
$o**on (toc 1,000,000 550,000 550,000 1,000,000
etained ea"ning( 558,000 340,000 425,100 168,000 7,300 633,600
1=1 #$% in net a((et( 8,000 242,500 224,100
10,400
&otal lia> ; e.uit/ 1,780,000+ 1,030,000+ 1,938,500+ 1,938,500+ 2,227,000+
Eli*ination(
LO 3 Allocation of difference in a partially owned subsidiary$LO 3 Allocation of difference in a partially owned subsidiary$ %ubse!uent
8ear

e!. *etained $arnin!s orter Co. "&;<;;;

%ubse!uent 8ear
8ncrease 1)','''
B 12','''

Dividends declared 3=<;;;
Common stock 3 Salem ..;<;;;
Difference between Cost and ook 3>&<.;;
8nvestment in Salem ?@;<;;;

?oncontrollin! interest in e"uity &3&<.;;
%ubse!uent 8ear

=and .<;;;

lant and e"uipment ">;<;;;
%ubse!uent 8ear

Slide
5-30 LO 3 Allocation of difference in a partially owned subsidiary$LO 3 Allocation of difference in a partially owned subsidiary$

Depreciation e%pense /B1#',''')0 &<;;;
lant and e"uipment @=<;;;
11 *etained $arnin!s I orter /2 years0 3"<;;
%ubse!uent 8ear
Eoodwill 3@<.;;

5-31 LO . 'ecording investment by )arent< complete e!uity method$LO . 'ecording investment by )arent< complete e!uity method$

#onsolidated %tatements 9 )artial and#onsolidated %tatements 9 )artial and #omplete -!uity :ethods #omplete -!uity :ethods
Ghe e"uity methods /partial and complete0 reflect
the effects of certain transactions more fully than
the cost method on the books of the parent.
Jowever consolidated totals are the same re!ardless
of which method is used by the arent company.

Slide
5-32
?otes payable, lon!3term debt, and other obli!ations of an ac"uired 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+
Ghe liability is transferred to a market participant and
Ghe nonperformance risk relatin! to the liability is the same before and after its transfer.

Additional #onsiderations 'elating to 6reatment of Additional #onsiderations 'elating to 6reatment of Difference Between Implied and Book Values Difference Between Implied and Book Values
Allocation of Difference between Implied and Book Values to Long/6erm Debt

Slide
5-33
Go measure fair value, use valuation techni"ues that are consistent with the market approach or income approach.
Luoted market prices are the best. 8f unavailable, then
mana!ement’s best estimate based on
debt with similar characteristics or
valuation techni"ues such as present value.

Allocation of Difference between Implied and Book Values to Long/6erm Debt

@n the date of ac"uisition, sometimes the
fair value of an asset is less than the amount recorded on
the books of the subsidiary.
fair value of lon!3term debt may be !reater rather than
less than its recorded value on the books of the
subsidiary.

Allocating the Difference to Assets 4Liabilities5 with *air Values Less 4(reater5 6han Book Values

-./"-./" 4Variation54Variation5 @n anuary 1, 2'1', am Company purchased an
4)( interest in Shaw Company for B)&','''. @n this date, Shaw
$"uipment 4. year life5 12',''' 1'',''' 4&;<;;;5
Allocating the Difference to Assets 4Liabilities5 with *air Values Less 4(reater5 6han Book Values


the difference between book value of e"uity ac"uired and the
value implied by the purchase price.

85 15 100
$o**on (toc 340,000 60,000 400,000
etained ea"ing( 119,000 21,000 140,000
&otal oo value 459,000 81,000 540,000
a"etale (ecu"itie( 21,250 3,750 25,000
E.ui)*ent 17,000 3,000 20,000
alance 76,750 13,544 90,294
alance -+ -+ -+
LO = Allocating when the fair value is below book value$LO = Allocating when the fair value is below book value$
Cost ethod
Slide
5-37
-./" 4variation5-./" 4variation5 At the end of the firstfirst year, the workpaper
entries are+

$"uipment,net &,'''
Depreciation e%pense /B2',''' ) years0 &,'''
7ote+ the overvaluation of e"uipment will be amorti<ed over the life of the asset as a reduction of depreciation e%pense.
Cost ethod
Slide
5-38
-./" 4variation5-./" 4variation5 At the end of the secondsecond year, the workpaper
entries are+

$"uipment, net 4,'''
e!. retained earnin!s 3 am #,&''
?oncontrollin! interest in e"uity -''
Cost ethod
-./@-./@ @n anuary 1, 2'11, ackard Company purchased an 4'(
interest in Sa!e Company for B-'','''. @n this date Sa!e Company
had common stock of B1)',''' and retained earnin!s of B&'','''.
Sa!e Company’s e"uipment on the date of ackard Company’s
purchase had a book value of B&'',''' and a fair value of
B-'','''. All e"uipment had an estimated useful life of 1' years on
anuary 2, 2''-.
statements workpaper entries for 2'11 and 2'12, recordin!
accumulated depreciation as a separate balance.
'eporting Accumulated Depreciation in #onsolidated *inancial %tatements as a %eparate Balance
LO ? Depreciable assets at net and gross values$LO ? Depreciable assets at net and gross values$

80 20 100
$o**on (toc 120,000 30,000 150,000
etained ea"ing( 320,000 80,000 400,000
&otal oo value 440,000 110,000 550,000
E.ui)*ent 160,000 40,000 200,000
alance -+ -+ -+

-./@-./@ repare the December #1 consolidated financial statements workpaper entries for &;"" and 2'12.

$"uipment &'','''
Depreciation $%pense /B2'',''')0 &','''
Cost > artial $"uity ethod

-./@-./@ repare the December #1 consolidated financial statements workpaper entries for 2'11 and &;"&.

$"uipment &'','''
11 *etained $arnin!s 3ackard Co. #2,'''
11 ?oncontrollin! interest 4,'''
Depreciation $%pense /B2'',''')0 &','''
Accumulated Depreciation 4','''
M Complete e"uity method+ debit to 11 *etained $arnin!s I ackard Co. would be replaced with a debit to 8nvestment in Sa!e Company
Cost > artial $"uity ethod
Disposal of Depreciable Assets by %ubsidiary

8n the year of sale, any !ain or loss reco!ni<ed 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 ad7usted in the consolidated statements workpaper.
Depreciable Assets sed in :anufacturing

Slide
5-44 LO "; )ush down of accounting to the subsidiary+s books$LO "; )ush down of accounting to the subsidiary+s books$
)ush Down Accounting )ush Down Accounting

)ush down accounting is the establishment of a new
accountin! and reportin! basis for a subsidiary company in its
separate financial statements based on the purchase price
paid by the parent to ac"uire the controllin! interest.
Ghe valuation implied by the price of the stock to the parent
company is Npushed downO to the subsidiary and used to
restate its assets /includin! !oodwill0 and liabilities in its
separate financial statements.
Slide

Arguments for and against )ush Down Accounting
Ghree important factors that should be considered in
determinin! the appropriateness of push down accountin! are+
1. 6hether the subsidiary has outstandin! debt held by the
public.
2. 6hether the subsidiary has outstandin! a senior class of
capital stock not ac"uired by the parent company.
#. Ghe level at which a ma7or chan!e in ownership of an entity
should be deemed to have occurred, for e%ample, 1''(, 5'(,
)1(.
Slide

%tatus of )ush Down Accounting
As a general rule< the %-# re!uires push down accounting when
the ownership change is greater than ?.C and objects to push
down accounting when the ownership change is less than =;C.
8n addition, the S$C staff e%presses the view that the e%istence of
outstandin! public debt, preferred stock, or a si!nificant
noncontrollin! interest in a subsidiary mi!ht impact the parent
company’s ability to control the form of ownership. 8n these
circumstances, push down accountin!, thou!h not re"uired, is an
acceptable accountin! method.
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chapter 5 advanced accounting