CH 05

5
Allocation and Depreciation of Differences Between Implied and Book Values Acquisition
Advanced Accounting, Fifth Edition

Slide 5-1
Learning Objectives
1. 2. 3. 4. 5. 6. Calculate the difference between implied and book values and allocate to the subsidiarys assets and liabilities. Describe FASBs 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 parents books to account for the investment under the three methods: the cost, the partial equity, and the complete equity methods. 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. Understand the allocation of the difference between implied and book values to longterm 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.
7. 8. 9.
10. Understand the concept of push down accounting.

Slide 5-2
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.
Slide 5-3
LO 1 Computation and Allocation of Difference.

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.

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 FASBs position on accounting for bargain acquisitions.
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 FASBs position on accounting for bargain acquisitions.

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.
Slide 5-7
LO 2 FASBs position on accounting for bargain acquisitions. .
Allocation of 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 Companys assets and liabilities revealed that their book value was equal to their fair value except for marketable securities and equipment:
Book Value
Marketable securities Equipment $ 20,000 120,000
Fair Value
$ 45,000 140,000
Difference
$ 25,000 20,000
Slide 5-8
LO 4 Allocation of difference in a partially owned subsidiary.
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.
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
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
LO 4 CAD Schedule for less than wholly owned subsidiary.
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 Retained earnings Difference between Implied and Book Investment in Shaw Noncontrolling interest in Equity 400,000 140,000 95,294 540,000 95,294
Marketable securities 25,000 Equipment 20,000 Goodwill 50,294 Difference between Implied and Book
Slide 5-10
95,294
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 Companys assets and liabilities revealed that their book value was equal to their fair value except for marketable securities and equipment:
Book Value
Marketable securities Equipment $ 20,000 120,000
Fair Value
$ 45,000 140,000
Difference
$ 25,000 20,000
Slide 5-11
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
E5-1 (variation): Prepare the worksheet entries.
Common stock Retained earnings Difference between Implied and Book Investment in Shaw Noncontrolling interest in Equity Marketable securities Equipment Gain on acquisition Noncontrolling interest in equity Difference between Implied and Book
Slide 5-13
400,000 140,000 12,941 470,000 82,941 25,000 20,000 27,250 4,809 12,941
Effect of Allocation and Depreciation of Differences 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.
Slide 5-14
Consolidated Statements Cost 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:
Fair Value in Excess of Book Value
Equipment Land Inventory $ 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 Acquisition

P5-4: Salem Companys 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 Cash Cash Dividend income ($25,000 x 80%)
Year of Acquisition
850,000 850,000 20,000 20,000
Slide 5-16

P5-4: A. Prepare a Computation and Allocation Schedule
80% Parent Share $ 850,000 440,000 64,000 504,000 346,000 (104,000) (52,000) (32,000) 158,000 (158,000) $ 20% NCI Share $ 212,500 110,000 16,000 126,000 86,500 (26,000) (13,000) (8,000) 39,500 (39,500) $ 100% Total Value $ 1,062,500 550,000 80,000 630,000 432,500 (130,000) (65,000) (40,000) 197,500 (197,500) $ -
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
Year of Acquisition

P5-4: B. 1. Prepare the worksheet entries for Dec. 31, 2010.
Dividend income ($25,000 x 80%) Dividends declared 20,000 20,000
Beg. retained earnings - Salem

Common stock - Salem Difference between Cost and Book Investment in Salem Noncontrolling interest in equity
Year of Acquisition
80,000
550,000 432,500 850,000 212,500
Slide 5-18

P5-4: B. 1. Prepare the worksheet entries for Dec. 31, 2010.
Cost of goods sold Land 40,000 65,000
Plant and equipment

Goodwill Difference between cost and book Depreciation expense ($130,000/5) Plant and equipment
Slide 5-19
130,000
197,500 432,500 26,000 26,000
Year of Acquisition

P5-4: C. 1. Prepare the worksheet entries for Dec. 31, 2011.
Salem 2011 income Salem 2011 dividends declared Total Ownership percentage $100,000 - 25,000 75,000 80% $ 60,000
60,000 60,000
Investment in Salem Beg. Retained Earnings - Porter Co.
To establish reciprocity/convert to equity as of 1/1/2011

Subsequent Year
Slide 5-20


Subsequent Year
155,000
550,000 432,500 910,000 227,500
Slide 5-21

1/1 Retained Earnings Porter Noncontrolling interest Land Plant and equipment Goodwill Difference between cost and book 32,000 8,000 65,000 130,000 197,500 432,500
1/1 Retained Earnings Porter Noncontrolling interest

Depreciation expense ($130,000/5) Plant and equipment
Slide 5-22
20,800 5,200
26,000 52,000
Subsequent Year

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
Subsequent Year

P5-4: D. 2012
Income Statement Sales Dividend income Total revenue Cost of goods sold Depreciation expense Impairment loss Other expenses Total cost and expense Net income Noncontrolling interest Net income
Year Subsequent of Acquisition

Porter Salem $ 1,100,000 $ 450,000 48,000 1,148,000 450,000 900,000 200,000 40,000 30,000 60,000 1,000,000 148,000 $ 50,000 280,000 170,000 19,300 $ 19,300 $ 120,000 Eliminations Debit Credit 48,000 1,550,000 1,100,000 96,000 47,500 110,000 1,353,500 196,500 (19,300) 177,200 546,400 NCI Consolidated Balances $ 1,550,000
26,000 47,500
148,000 $ 170,000 $ 121,500 500,000 230,000 32,000 41,600 230,000 121,500
Retained Earnings Statement Retained earnings, 1/1/12 Porter Salem Net income Dividends declared Retained earnings, 12/31/12 $
Slide 5-24
148,000 170,000 19,300 (90,000) (60,000) 48,000 (12,000) 558,000 $ 340,000 $ 425,100 $ 168,000 $ 7,300 $
177,200 (90,000) 633,600
Subsequent Year

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 $
Year Subsequent of Acquisition

Porter 70,000 260,000 240,000 850,000 $ Salem 65,000 190,000 175,000 Eliminations Debit Credit NCI Consolidated Balances $ 135,000 450,000 415,000
360,000 $ $ 1,780,000 132,000 90,000 1,000,000 558,000 $ $
320,000 280,000 1,030,000 110,000 30,000 550,000 340,000
120,000 432,500 65,000 130,000 197,500
970,000 432,500 78,000 47,500 $ $ 385,000 692,000 150,000 2,227,000 242,000 120,000 1,000,000 633,600
550,000 425,100 8,000 10,400 $ 1,938,500
168,000 242,500
7,300 224,100 231,400
12/31 NCI in net asset Total liab. & equity $
1,780,000
1,030,000
$ 1,938,500
231,400 2,227,000
Slide 5-25
Subsequent Year

P5-4: D. Explanations of worksheet entries for Dec. 31, 2012.
Acquisition date retained earnings - Salem Retained earnings 1/1/12 - Salem Increase Ownership percentage $ 80,000 230,000 150,000 80% $ 120,000
120,000 120,000
Investment in Salem Beg. Retained Earnings - Porter Co.
To establish reciprocity/convert to equity as of 1/1/2012

Subsequent Year
Slide 5-26

P5-4 D. Worksheet entries for Dec. 31, 2012.

Subsequent Year
230,000
550,000 432,500 970,000 242,500
Slide 5-27

1/1 Retained Earnings Porter Noncontrolling interest 32,000 8,000
Land
Plant and equipment
65,000
130,000
Goodwill
Difference between cost and book
197,500
432,500
Slide 5-28
Subsequent Year

1/1 Retained Earnings Porter (2 years) Noncontrolling interest (2 years) 41,600 10,400
Depreciation expense ($130,000/5) Plant and equipment
26,000 78,000
Impairment loss ($197,500 - $150,000) Goodwill

To record goodwill impairment
Slide 5-29
47,500 47,500
Subsequent Year
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.
LO 5 Recording investment by Parent, partial equity method.

Slide 5-30
LO 5 Recording investment by Parent, complete equity method.
Additional Considerations Relating to Treatment of Difference Between Implied and Book Values
Allocation of Difference between Implied and Book Values to Long-Term Debt
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 and
The
nonperformance risk relating to the liability is the same before and after its transfer.
Slide 5-31
LO 7 Allocating difference to long-term debt.
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 market prices are the best. If unavailable, then managements best estimate based on debt with similar characteristics or valuation techniques such as present value.
Slide 5-32
LO 7 Allocating difference to long-term debt.
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.
Slide 5-33
LO 8 Allocating when the fair value is below book value.
Allocating the Difference to Assets (Liabilities) with Fair Values Less (Greater) Than Book Values
E5-1 (Variation): 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 Companys assets and liabilities revealed that their book value was equal to their fair value except
for marketable securities and equipment:

Book Value
Marketable securities Equipment (5 year life)
Slide 5-34
Fair Value
$ 45,000 100,000
Difference
$ 25,000 (20,000)
20,000 120,000
Cost Method
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.
85% Parent Share $ 540,000 340,000 119,000 459,000 81,000 (21,250) 17,000 76,750 (76,750) $ 15% NCI Share $ 95,294 60,000 21,000 81,000 14,294 (3,750) 3,000 13,544 (13,544) 100% Total Value $ 635,294 400,000 140,000 540,000 95,294 (25,000) 20,000 90,294 (90,294) $ -
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 5-35
Cost Method
E5-1 (variation): At the end of the first year, the workpaper entries are:
Marketable securities Goodwill Difference between Implied and Book Equipment Equipment,net Depreciation expense ($20,000 / 5 years) 4,000 4,000 25,000 90,294 95,294 20,000
Note: the overvaluation of equipment will be amortized over the life of the asset as a reduction of depreciation expense.
Slide 5-36
Cost Method
E5-1 (variation): At the end of the second year, the workpaper entries are:
Marketable securities Goodwill Difference between Implied and Book Equipment Equipment, net Beg. retained earnings - Pam Noncontrolling interest in equity Depreciation expense ($20,000 / 5 years)
Slide 5-37
25,000 90,294 95,294 20,000 8,000 3,400 600 4,000
Reporting Accumulated Depreciation in Consolidated Financial Statements as a Separate Balance
E5-7: On January 1, 2011, Packard Company purchased an 80% interest in Sage Company for $600,000. On this date Sage Company had common stock of $150,000 and retained earnings of $400,000. Sage Companys equipment on the date of Packard Companys purchase had a book value of $400,000 and a fair value of $600,000. All equipment had an estimated useful life of 10 years on January 2, 2006. Required: Prepare the December 31 consolidated financial statements workpaper entries for 2011 and 2012, recording accumulated depreciation as a separate balance.
Slide 5-38
LO 9 Depreciable assets at net and gross values.
E5-7: Prepare a Computation and Allocation Schedule.
80% Parent Share $ 600,000 120,000 320,000 440,000 160,000 (160,000) $ 20% NCI Share $ 150,000 30,000 80,000 110,000 40,000 (40,000) 100% Total Value $ 750,000 150,000 400,000 550,000 200,000 (200,000) $ -
Purchase price and implied value Book value of equity acquired: Common stock Retained earings Total book value Difference between implied and book value Equipment Balance
Slide 5-39
Cost & Partial Equity Method
E5-7: Prepare the December 31 consolidated financial statements workpaper entries for 2011 and 2012.
Equipment Accumulated depreciation Difference between Implied and Book 400,000 200,000 200,000
Depreciation Expense ($200,000/5)

Accumulated Depreciation
40,000
40,000
Slide 5-40
Cost & Partial Equity Method
E5-7: Prepare the December 31 consolidated financial statements workpaper entries for 2011 and 2012.
Equipment Accumulated depreciation Difference between Implied and Book 1/1 Retained Earnings -Packard Co. 1/1 Noncontrolling interest Depreciation Expense ($200,000/5) Accumulated Depreciation 32,000 8,000 40,000 80,000 400,000 200,000 200,000
* Complete equity method: debit to 1/1 Retained Earnings Packard Co. would be replaced with a debit to Investment in Sage Company
Slide 5-41
Disposal of Depreciable Assets by Subsidiary
In the year of sale, any gain or loss recognized 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 adjusted in the consolidated statements workpaper.
Depreciable Assets Used in Manufacturing

When the difference between implied and book values is allocated to depreciable assets used in manufacturing, workpaper entries may be more complex because the current and previous years additional depreciation may need to be allocated among work in process, finished goods, and cost of goods sold.
Slide 5-42
Push Down Accounting

Push down accounting is the establishment of a new accounting and reporting basis for a subsidiary company in its separate financial statements based on the purchase price paid by the parent to acquire the controlling interest. The valuation implied by the price of the stock to the parent company is pushed down to the subsidiary and used to restate its assets (including goodwill) and liabilities in its separate financial statements.
Slide 5-43
LO 10 Push down of accounting to the subsidiarys books.

Arguments for and against Push Down Accounting
Three important factors that should be considered in determining the appropriateness of push down accounting are:
1. Whether the subsidiary has outstanding debt held by the public.
2. Whether the subsidiary has outstanding a senior class of

capital stock not acquired by the parent company. 3. The level at which a major change in ownership of an entity should be deemed to have occurred, for example, 100%, 90%, 51%.
Slide 5-44

Status of Push Down Accounting
As a general rule, the SEC requires push down accounting when
the ownership change is greater than 95% and objects to push

down accounting when the ownership change is less than 80%. In addition, the SEC staff expresses the view that the existence of
outstanding public debt, preferred stock, or a significant

noncontrolling interest in a subsidiary might impact the parent companys ability to control the form of ownership. In these circumstances, push down accounting, though not required, is an acceptable accounting method.
Slide 5-45
Copyright
Copyright 2012 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.
Slide 5-46

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5

Advanced Accounting, Fifth Edition

10. Understand the concept of push down accounting.

Allocation of Difference Between Implied and Book Values: Acquisition Date

difference between implied and book values to specific

LO 1 Computation and Allocation of Difference.

Allocation of Difference Between Implied and Book Values: Acquisition Date

Step 2: Any residual amount:

LO 1 Computation and Allocation of Difference.

Allocation of Difference Between Implied and Book Values: Acquisition Date

2. Previously recorded goodwill is eliminated.

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)

LO 2 FASBs position on accounting for bargain acquisitions.

Allocation of Difference Between Implied and Book Values: Acquisition Date

a. an ordinary gain is reported in the financial statements of the consolidated entity.

c. negative goodwill is reported on the balance sheet.

LO 2 FASBs position on accounting for bargain acquisitions. .

interest in Shaw Company for $540,000. On this date, Shaw

LO 4 Allocation of difference in a partially owned subsidiary.

LO 4 CAD Schedule for less than wholly owned subsidiary.

LO 4 Allocation of difference in a partially owned subsidiary.

85% interest in Shaw Company for $470,000. On this date, Shaw

LO 4 Allocation of difference in a partially owned subsidiary.

LO 4 Allocation of difference in a partially owned subsidiary.

LO 4 Allocation of difference in a partially owned subsidiary.

Adjustment is needed to reflect the difference between

consolidated carrying values.

LO 4 Allocation of difference in a partially owned subsidiary.

Consolidated Statements Cost Method

LO 4 Allocation of difference in a partially owned subsidiary.

Consolidated Statements Cost Method

850,000 850,000 20,000 20,000

LO 4 Allocation of difference in a partially owned subsidiary.

Consolidated Statements Cost Method

LO 4 Allocation of difference in a partially owned subsidiary.

Consolidated Statements Cost Method

Beg. retained earnings - Salem

LO 4 Allocation of difference in a partially owned subsidiary.

Consolidated Statements Cost Method

Plant and equipment

LO 4 Allocation of difference in a partially owned subsidiary.

Consolidated Statements Cost Method

Investment in Salem Beg. Retained Earnings - Porter Co.

To establish reciprocity/convert to equity as of 1/1/2011

LO 4 Allocation of difference in a partially owned subsidiary.

Consolidated Statements Cost Method

Beg. retained earnings - Salem

LO 4 Allocation of difference in a partially owned subsidiary.

Consolidated Statements Cost Method

1/1 Retained Earnings Porter Noncontrolling interest

LO 4 Allocation of difference in a partially owned subsidiary.

Consolidated Statements Cost Method

no goodwill impairment was reflected at the end of 2010 or

LO 4 Allocation of difference in a partially owned subsidiary.

Consolidated Statements Cost Method

Year Subsequent of Acquisition

148,000 $ 170,000 $ 121,500 500,000 230,000 32,000 41,600 230,000 121,500

177,200 (90,000) 633,600

LO 4 Allocation of difference in a partially owned subsidiary.

Consolidated Statements Cost Method

Year Subsequent of Acquisition