Advanced Accounting Jeter ● Chaney Allocation and Depreciation of Differences Between Implied and Book Values Prepared by Sheila Ammons, Austin Community College 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 Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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 Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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 Computation and Allocation of Difference (CAD) Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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 (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 LO Computation and Allocation of Difference (CAD) Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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 Current and past treatment of bargain acquisitions Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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) 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 LO Current and past treatment of bargain acquisitions Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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: 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 LO Current and past treatment of bargain acquisitions Copyright © 2015 John Wiley & Sons, Inc All rights reserved Allocation of Difference Case 1: Implied Value “in Excess of” Fair Value 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: LO Computation and Allocation of Difference (CAD) LO Allocation of difference in a partially owned subsidiary Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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 CAD Schedule for less than wholly owned subsidiary Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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, 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: LO Allocating when the fair value is below book value Copyright © 2015 John Wiley & Sons, Inc All rights reserved Allocation of Difference 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 LO Allocating when the fair value is below book value Copyright © 2015 John Wiley & Sons, Inc All rights reserved Allocation of Difference Cost Method 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 Value 95,294 Equipment, net Equipment 4,00020,000 Depreciation Expense ($20,000 / years) Note: The overvaluation of equipment will be amortized over the life of the4,000 asset as a reduction of depreciation expense LO Allocating when the fair value is below book value Copyright © 2015 John Wiley & Sons, Inc All rights reserved Allocation of Difference Cost Method 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 Value 95,294 Equipment, net Equipment 8,00020,000 Beg Retained Earnings - Pam Noncontrolling Interest in Equity 3,400 Depreciation Expense ($20,000 / years) 600 4,000 LO Allocating when the fair value is below book value Copyright © 2015 John Wiley & Sons, Inc All rights reserved Allocation of Difference Reporting Accumulated Depreciation in Consolidated Financial Statements as a Separate Balance • E5-7: On January 1, 2014, 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, 2009 Required: Prepare the December 31 consolidated financial statements workpaper entries for 2014 and 2015, recording accumulated depreciation as a separate balance LO Depreciable assets at net and gross values Copyright © 2015 John Wiley & Sons, Inc All rights reserved Allocation of Difference E5-7: Prepare a Computation and Allocation Schedule LO Depreciable assets at net and gross values Copyright © 2015 John Wiley & Sons, Inc All rights reserved Allocation of Difference E5-7: Prepare the December 31 consolidated financial statements workpaper entries for 2014 and 2015 Equipment 400,000* Accumulated Depreciation Difference between Implied and Book Value 200,000** Cost & Partial Equity Method 200,000 LO Depreciable assets at net and gross values Copyright © 2015 John Wiley & Sons, Inc All rights reserved Allocation of Difference E5-7: Prepare the December 31 consolidated financial statements workpaper entries for 2014 and 2015 Depreciation Expense ($200,000/5) 40,000 Accumulated Depreciation Cost & Partial Equity Method 40,000 LO Depreciable assets at net and gross values Copyright © 2015 John Wiley & Sons, Inc All rights reserved Allocation of Difference E5-7: Prepare the December 31 consolidated financial statements workpaper entries for 2014 and 2015 Equipment 400,000 Accumulated Depreciation Difference between Implied and Book Value 200,000 1/1 Retained Earnings -Packard Co 200,000 1/1 Noncontrolling Interest Depreciation Expense ($200,000/5) 32,000 Cost & Partial 8,000 Equity Method 40,000 Accumulated Depreciation * Complete equity method: debit to 1/1 Retained Earnings – Packard Co would be replaced with a debit to Investment in Sage Company 80,000 LO Depreciable assets at net and gross values Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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 Depreciable assets at net and gross values Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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 Copyright © 2015 John Wiley & Sons, Inc All rights reserved Push Down Accounting •Push down accounting is based on the notion that the basis of accounting for purchased assets and liabilities should be the same regardless of whether the acquired company continues as a separate subsidiary or is merged into the parent company’s operations –The parent’s cost of acquiring a subsidiary is used to establish a new accounting basis for the assets and liabilities of the subsidiary in the subsidiary’s separate financial statements –Because push down accounting has not been addressed in authoritative pronouncements of the FASB or its predecessors, practice has been inconsistent LO 10 Push down of accounting to the subsidiary’s books Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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: 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% LO 10 Push down of accounting to the subsidiary’s books Copyright © 2015 John Wiley & Sons, Inc All rights reserved Push Down Accounting Status of Push Down Accounting On January 17, 2013, FASB’s Emerging Issues Task Force • Decided: To consider at a future meeting whether push down accounting should be mandatory That push down accounting would be required for public business entities under specified circumstances •Tentatively Decided: To allow public business entities and non-public entities to have an option to apply push down accounting upon occurrence of a change-in-control event LO 10 Push down of accounting to the subsidiary’s books Copyright © 2015 John Wiley & Sons, Inc All rights reserved 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 Copyright © 2015 John Wiley & Sons, Inc All rights reserved ... the same regardless of which method is used by the Parent company LO Recording investment by Parent, partial equity method LO Recording investment by Parent, complete equity method Copyright... subsidiary depreciable assets at net versus gross fair values • Understand the concept of push down accounting Copyright © 2015 John Wiley & Sons, Inc All rights reserved Allocation of Difference... 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