1. Advanced Accounting, Fifth Edition9
Allocation and Depreciation of Differences Between Implied and Book Values Acquisition
Advanced Accounting, Fifth Edition

2. 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.
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 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.

3. 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.
LO 1 Computation and Allocation of Difference.

4. Allocation of Difference Between Implied and Book Values: Acquisition 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.
LO 1 Computation and Allocation of Difference.

5. Allocation of Difference Between Implied and Book Values: Acquisition Date
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.
LO 2 FASB’s position on accounting for bargain acquisitions.

6. Allocation of Difference Between Implied and Book Values: Acquisition Date
Bargain Rules: When a bargain acquisition occurs, under FASB ASC paragraph , 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.
LO 2 FASB’s position on accounting for bargain acquisitions.

7. Allocation of Difference Between Implied and Book Values: Acquisition 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:
an ordinary gain is reported in the financial statements of the consolidated entity.
an ordinary loss is reported in the financial statements of the consolidated entity.
negative goodwill is reported on the balance sheet.
assets are written down to zero value, if needed.
LO 2 FASB’s position on accounting for bargain acquisitions. .

8. 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 Company’s assets and liabilities revealed that their book value was equal to their fair value except for marketable securities and equipment:
LO 4 Allocation of difference in a partially owned subsidiary.

9. Allocation of 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.
LO 4 CAD Schedule for less than wholly owned subsidiary.

10. Allocation of 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 540,000
Noncontrolling interest in Equity 95,294
Marketable securities 25,000
Equipment 20,000
Goodwill 50,294
Difference between Implied and Book 95,294
LO 4 Allocation of difference in a partially owned subsidiary.

11. Allocation of 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:
LO 4 Allocation of difference in a partially owned subsidiary.

12. Allocation of Difference
E5-1 (variation): Prepare a Computation and Allocation Schedule.
LO 4 Allocation of difference in a partially owned subsidiary.

13. Allocation of 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 470,000
Noncontrolling interest in Equity 82,941
Marketable securities 25,000
Equipment 20,000
Gain on acquisition 27,250
Noncontrolling interest in equity 4,809
Difference between Implied and Book 12,941
LO 4 Allocation of difference in a partially owned subsidiary.

14. 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.
LO 4 Allocation of difference in a partially owned subsidiary.

15. 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:
The book values of all other assets and liabilities of Salem Company were equal to their fair values on January 1, The equipment had a remaining life of five years. The inventory was sold in 2010.
Year of Acquisition
LO 4 Allocation of difference in a partially owned subsidiary.

16. Consolidated Statements – Cost 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 850,000
Cash 20,000
Dividend income ($25,000 x 80%) 20,000
Year of Acquisition
LO 4 Allocation of difference in a partially owned subsidiary.

17. Consolidated Statements – Cost Method
P5-4: A. Prepare a Computation and Allocation Schedule
Year of Acquisition
LO 4 Allocation of difference in a partially owned subsidiary.

18. Consolidated Statements – Cost Method
P5-4: B. 1. Prepare the worksheet entries for Dec. 31, 2010.
Dividend income ($25,000 x 80%) 20,000
Dividends declared 20,000
Beg. retained earnings - Salem 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 Acquisition
LO 4 Allocation of difference in a partially owned subsidiary.

19. Consolidated Statements – Cost 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 432,500
Depreciation expense ($130,000/5) 26,000
Plant and equipment 26,000
Year of Acquisition
LO 4 Allocation of difference in a partially owned subsidiary.

20. Consolidated Statements – Cost Method
P5-4: C. 1. Prepare the worksheet entries for Dec. 31, 2011.
Salem 2011 income $100,000
Salem 2011 dividends declared - 25,000
Total 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
Subsequent Year
LO 4 Allocation of difference in a partially owned subsidiary.

21. Consolidated Statements – Cost Method
P5-4: C. 1. Prepare the worksheet entries for Dec. 31, 2011.
Dividend income ($35,000 x 80%) 28,000
Dividends declared 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
Subsequent Year
LO 4 Allocation of difference in a partially owned subsidiary.

22. Consolidated Statements – Cost Method
P5-4: C. 1. Prepare the worksheet entries for Dec. 31, 2011.
1/1 Retained Earnings – Porter 32,000
Noncontrolling interest 8,000
Land 65,000
Plant and equipment 130,000
Goodwill 197,500
Difference between cost and book 432,500
1/1 Retained Earnings – Porter 20,800
Noncontrolling interest 5,200
Depreciation expense ($130,000/5) 26,000
Plant and equipment 52,000
Subsequent Year
LO 4 Allocation of difference in a partially owned subsidiary.

23. Consolidated Statements – Cost Method
P5-4: D. Prepare a consolidated financial statements workpaper for the year ended December 31, 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.)
Subsequent Year
LO 4 Allocation of difference in a partially owned subsidiary.

24. Consolidated Statements – Cost Method
P5-4: D Year Subsequent of Acquisition
Subsequent Year
LO 4 Allocation of difference in a partially owned subsidiary.

25. Consolidated Statements – Cost Method
P5-4: D Year Subsequent of Acquisition
Subsequent Year
LO 4 Allocation of difference in a partially owned subsidiary.

26. Consolidated Statements – Cost Method
P5-4: D. Explanations of worksheet entries for Dec. 31, 2012.
Acquisition date retained earnings - Salem $ 80,000
Retained earnings 1/1/12 - Salem 230,000
Increase 150,000
Ownership percentage 80%
$ 120,000
Investment in Salem 120,000
Beg. Retained Earnings ‑ Porter Co ,000
To establish reciprocity/convert to equity as of 1/1/2012
Subsequent Year
LO 4 Allocation of difference in a partially owned subsidiary.

27. Consolidated Statements – Cost Method
P5-4 D. Worksheet entries for Dec. 31, 2012.
Dividend income ($60,000 x 80%) 48,000
Dividends declared 48,000
Beg. retained earnings - Salem 230,000
Common stock - Salem 550,000
Difference between Cost and Book 432,500
Investment in Salem 970,000
Noncontrolling interest in equity 242,500
Subsequent Year
LO 4 Allocation of difference in a partially owned subsidiary.

28. Consolidated Statements – Cost Method
P5-4 D. Worksheet entries for Dec. 31, 2012.
1/1 Retained Earnings – Porter 32,000
Noncontrolling interest 8,000
Land 65,000
Plant and equipment 130,000
Goodwill 197,500
Difference between cost and book 432,500
Subsequent Year
LO 4 Allocation of difference in a partially owned subsidiary.

29. Consolidated Statements – Cost Method
P5-4 D. Worksheet entries for Dec. 31, 2012.
1/1 Retained Earnings – Porter (2 years) 41,600
Noncontrolling interest (2 years) 10,400
Depreciation expense ($130,000/5) 26,000
Plant and equipment 78,000
Impairment loss ($197,500 - $150,000) 47,500
Goodwill 47,500
To record goodwill impairment
Subsequent Year
LO 4 Allocation of difference in a partially owned subsidiary.

30. 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.
LO 5 Recording investment by Parent, complete equity method.

31. 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.
LO 7 Allocating difference to long-term debt.

32. Additional Considerations Relating to Treatment of Difference Between Implied and Book Values
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 management’s best estimate based on
debt with similar characteristics or
valuation techniques such as present value.
LO 7 Allocating difference to long-term debt.

33. Additional Considerations Relating to Treatment of Difference Between Implied and Book Values
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.
LO 8 Allocating when the fair value is below book value.

34. Additional Considerations Relating to Treatment of Difference Between Implied and Book Values
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 Company’s assets and liabilities revealed that their book value was equal to their fair value except for marketable securities and equipment:
LO 8 Allocating when the fair value is below book value.

35. Allocation of Difference
Cost Method
Allocation of 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.
LO 8 Allocating when the fair value is below book value.

36. Allocation of Difference
Cost Method
Allocation of Difference
E5-1 (variation): At the end of the first year, the workpaper entries are:
Marketable securities 25,000
Goodwill 90,294
Difference between Implied and Book 95,294
Equipment 20,000
Equipment,net 4,000
Depreciation expense ($20,000 / 5 years) 4,000
Note: the overvaluation of equipment will be amortized over the life of the asset as a reduction of depreciation expense.
LO 8 Allocating when the fair value is below book value.

37. Allocation of Difference
Cost Method
Allocation of Difference
E5-1 (variation): At the end of the second year, the workpaper entries are:
Marketable securities 25,000
Goodwill 90,294
Difference between Implied and Book 95,294
Equipment 20,000
Equipment, net 8,000
Beg. retained earnings - Pam 3,400
Noncontrolling interest in equity 600
Depreciation expense ($20,000 / 5 years) 4,000
LO 8 Allocating when the fair value is below book value.

38. Allocation of Difference
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 Company’s equipment on the date of Packard Company’s 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.
LO 9 Depreciable assets at net and gross values.

39. Allocation of Difference
E5-7: Prepare a Computation and Allocation Schedule.
LO 9 Depreciable assets at net and gross values.

40. Allocation of Difference
Cost & Partial Equity Method
Allocation of Difference
E5-7: Prepare the December 31 consolidated financial statements workpaper entries for 2011 and 2012.
Equipment 400,000
Accumulated depreciation 200,000
Difference between Implied and Book 200,000
Depreciation Expense ($200,000/5) 40,000
Accumulated Depreciation 40,000
LO 9 Depreciable assets at net and gross values.

41. Allocation of Difference
Cost & Partial Equity Method
Allocation of Difference
E5-7: Prepare the December 31 consolidated financial statements workpaper entries for 2011 and 2012.
Equipment 400,000
Accumulated depreciation 200,000
Difference between Implied and Book 200,000
1/1 Retained Earnings -Packard Co ,000
1/1 Noncontrolling interest 8,000
Depreciation Expense ($200,000/5) 40,000
Accumulated Depreciation 80,000
* Complete equity method: debit to 1/1 Retained Earnings – Packard Co. would be replaced with a debit to Investment in Sage Company
LO 9 Depreciable assets at net and gross values.

42. Allocation of Difference
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.
LO 9 Depreciable assets at net and gross values.

43. 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.
LO 10 Push down of accounting to the subsidiary’s books.

44. Push Down Accounting Arguments for and against Push Down Accounting
Three important factors that should be considered in determining the appropriateness of push down accounting are:
Whether the subsidiary has outstanding debt held by the public.
Whether the subsidiary has outstanding a senior class of capital stock not acquired by the parent company.
The level at which a major change in ownership of an entity should be deemed to have occurred, for example, 100%, 90%, 51%.
LO 10 Push down of accounting to the subsidiary’s books.

45. Push Down Accounting 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 company’s ability to control the form of ownership. In these circumstances, push down accounting, though not required, is an acceptable accounting method.
LO 10 Push down of accounting to the subsidiary’s books.

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