Solution manual advanced accounting 9e by hoyle ch03

The parent adjusts its own Investment account to reflect the subsidiary’s income and dividend payments as well as any amortization expense relating to excess acquisition-date fair value

CHAPTER 3 CONSOLIDATIONS—SUBSEQUENT TO

THE DATE OF ACQUISITION

I Several factors serve to complicate the consolidation process when it occurs

subsequent to the date of acquisition In all combinations within its own internal records the acquiring company will utilize a specific method to account for the investment in the acquired company

1 Three alternatives are available

a Initial value method (formerly called the cost method prior to SFAS 141R)

b Equity method

c Partial equity method

2 Depending upon the method applied, the acquiring company will record earnings from its ownership of the acquired company This total must be eliminated on the consolidation worksheet and be replaced by the subsidiary’s revenues and expenses

3 Under each of these three methods, the balance in the Investment account will also vary It too must be removed in producing consolidated statements and be replaced by the subsidiary’s assets and liabilities

II For combinations being consolidated after the acquisition date, certain procedures are

required If the acquiring company has applied the equity method, the following process

is appropriate

A Assuming that the acquisition was made during the current fiscal period

1 The parent adjusts its own Investment account to reflect the subsidiary’s income and dividend payments as well as any amortization expense relating to excess acquisition-date fair value over book value allocations and goodwill

2 Worksheet entries are then used to establish consolidated figures for reporting purposes

a Entry S offsets the subsidiary’s stockholders’ equity accounts against the book value component of the Investment account (as of the acquisition date)

b Entry A recognizes the excess fair over book value allocations made to specific subsidiary accounts and/or to goodwill

c Entry I eliminates the investment income balance accrued by the parent

d Entry D removes intercompany dividend payments

e Entry E records the current excess amortization expenses on the excess fair over book value allocations

f Entry P eliminates any intercompany payable/receivable balances

B Assuming that the acquisition was made during a previous fiscal period

1 Most of the consolidation entries described above remain applicable regardless

of the time that has elapsed since the combination was formed

2 The amount of the subsidiary’s stockholders’ equity to be removed in Entry S will differ each period to reflect the balance as of the beginning of the current year

3 The allocations established by entry A will also change in each subsequent consolidation Only the unamortized balances remaining as of the beginning of the current period are recognized in this entry

III For a combination where the parent has applied an accounting method other than the

equity method, the consolidation procedures described above must be modified

A If the initial value method is applied by the parent company, the intercompany dividends eliminated in Entry I will only consist of the dividends transferred from the subsidiary No separate Entry D is needed

B If the partial equity method is in use, the intercompany income to be removed in Entry I is the equity accrual only; no amortization expense is included Intercompany dividends are eliminated through Entry D

C In any time period after the year of acquisition

1 The initial value method recognizes neither income in excess of dividend payments nor amortization expense Thus, for all years prior to the current period, both of these figures must be entered directly into the consolidation Entry*C is used for this purpose; it converts all prior amounts to equity method balances

2 The partial equity method does not recognize excess amortization expenses Therefore, Entry*C converts the appropriate account balances to the equity method by recognizing the expense that relates to all of the past years

IV Bargain purchases

A As discussed in Chapter Two, bargain purchases occur when the parent company transfers consideration less than net fair values of the subsidiary’s assets acquired and liabilities assumed

B According to SFAS 141R, the parent recognizes an excess of net asset fair value

over the consideration transferred as a ―gain on bargain purchase.‖

V Goodwill Impairment – SFAS No 142

A When is goodwill impaired?

1 Goodwill is considered impaired when the fair value of its related reporting unit

falls below its carrying value Goodwill should not be amortized, but should be

tested for impairment at the reporting unit level (operating segment or lower identifiable level)

2 Goodwill should be tested for impairment at least annually

3 Interim impairment testing may be necessary in the presence of negative indicators such as an adverse change in the business climate or market, legal factors, regulatory action, an introduction of competition, or a loss of key personnel

B How is goodwill tested for impairment?

1 All acquired goodwill should be assigned to reporting units It would not be unusual for the total amount of acquired goodwill to be divided among a number

of reporting units Goodwill may be assigned to reporting units of the acquiring entity that are expected to benefit from the synergies of the combination even though other assets or liabilities of the acquired entity may not be assigned to that reporting unit

2 Goodwill is tested for impairment using a two-step approach

a The first step simply compares the fair value of a reporting unit to its carrying amount If the fair value of the reporting unit exceeds its carrying amount, goodwill is not considered impaired and no further analysis is necessary

b The second step is a comparison of goodwill to its carrying amount If the implied value of a reporting unit’s goodwill is less than its carrying value,

goodwill is considered impaired and a loss is recognized The loss is equal

to the amount by which goodwill exceeds its implied value

3 The implied value of goodwill should be calculated in the same manner that goodwill is calculated in a business combination That is, an entity should allocate the fair value of the reporting unit to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the value assigned at a subsidiary’s acquisition date The excess

―acquisition-date‖ fair value over the amounts assigned to assets and liabilities is the implied value of goodwill This allocation is performed only for purposes of testing goodwill for impairment and does not require entities to record the ―step- up‖ in net assets or any unrecognized intangible assets

C How is the impairment recognized in financial statements?

A The aggregate amount of goodwill impairment losses should be presented as

a separate line item in the operating section of the income statement

unless a goodwill impairment loss is associated with a discontinued operation

B A goodwill impairment loss associated with a discontinued operation should

be included (on a net-of-tax basis) within the results of discontinued operations

VI Push-down accounting

A A subsidiary may record any acquisition-date fair value allocations directly onto its own financial records rather than through the use of a worksheet Subsequent amortization expense on these allocations could also be recorded by the subsidiary

B Push-down accounting reports the assets and liabilities of the subsidiary at the amount the new owner paid It also assists the new owner in evaluating the profitability that the subsidiary is adding to the business combination

C Push-down accounting can also make the consolidation process easier since allocations and amortization need not be included as worksheet entries

VII Contingent consideration

A Under SFAS 141R, the fair value of any contingent consideration is included as part

of the consideration transferred

B If the contingency is based on earnings or other financial performance measures,

C If the contingency requires additional stock to be issued at a later date (or any other equity issues), the acquisition-date fair value of the contingency is not adjusted over time Any subsequent shares issued as a consequence of the contingency are simply recorded at the original acquisition-date fair value

Learning Objectives

Having completed Chapter Three, ―Consolidations—Subsequent to the Date of Acquisition,‖ students should be able to fulfill each of the following learning objectives:

1 Identify and describe the three basic methods that an acquiring company can use in

accounting for its investment in an acquired company

2 Discuss the advantages and disadvantages of each of the three accounting methods

that an acquiring company can use in recording its investment

3 Determine consolidated balances at the end of the year in which a business combination

occurs if the parent uses either the initial value method, the equity method, or the partial equity method

4 Determine consolidated balances for any period subsequent to the year in which a

purchase combination is formed if the parent uses either the initial value method, the equity method, or the partial equity method

5 Understand the necessity for consolidation purposes of converting parent company

figures to the equity method when another method has been used during previous years

6 Understand the process of goodwill impairment and the techniques needed to calculate

a goodwill impairment for a reporting unit of a business combination

7 Account for additional amounts paid by a parent company or additional shares of stock

issued subsequent to the creation of a business combination

8 Explain the process of push-down accounting, identify its reporting advantages, and

indicate when this method is appropriate for external reporting

Answers to Discussion Questions

How Does a Company Really Decide which Investment Method to Apply?

Students can come up with literally dozens of factors that should be considered by Pilgrim in making the decision as to the method of accounting for its subsidiary, Crestwood Corporation The following is simply a partial list of possible points to consider

 Use of the information If Pilgrim does not monitor its own income levels closely, applying the equity method would seem to be a waste of time and energy A company must plan to use the additional data before the task of accumulation becomes worthwhile

 Size of the subsidiary If the subsidiary is large in comparison to Pilgrim, the effort required

of the equity method may be important Income levels would probably be significant

However, if the subsidiary is actually quite small in relation to the parent, the impact might not be material enough to warrant the extra effort

 Size of dividend payments If Crestwood pays out most of its earnings each period as dividends, that figure will approximate equity income Little additional information would be accrued by applying the equity method In contrast, if dividends are small or not paid on a regular basis, a Dividend Income balance might vastly understate the profits to be recognized by the business combination

 Amount of excess amortizations If Pilgrim has paid a significant amount in excess of book value so that annual amortization charges are quite high, use of the equity method might be preferred to show the effect of this expense each month (or whenever internal reporting is made) In this case, waiting until the end of the year and recording all of the expense at one time through a worksheet entry might not be the best way to reflect the impact of the expense

 Amount of intercompany transactions As with amortization, the volume of transfers can be

an important element in deciding which accounting method to use If few intercompany sales are made, monitoring the subsidiary through the application of the equity method is less essential Conversely, if the amount of these transactions IS significant, the added data can be helpful to company administrators evaluating operations

 Sophistication of accounting systems If Pilgrim and Crestwood both have advanced accounting systems, application of the equity method may be relatively simple Unfortunately, if these systems are primitive, the cost and effort necessary to apply the equity method may outweigh any potential benefits

 The timeliness and accuracy of income figures generated by Crestwood If the subsidiary reports operating results on a regular basis (such as weekly or monthly) and these figures prove to be reliable, equity totals recorded by Pilgrim may serve as valuable information to the parent However, if Crestwood's reports are slow and often require later adjustment, Pilgrim's use of the equity method will provide only questionable results

Answers to Questions

1 a CCES Corp., for its own recordkeeping, may apply the equity method to the

investment in Schmaling Under this approach, the parent's records parallel the activities of the subsidiary Income will be accrued by the parent as it is earned by the subsidiary Dividends paid by Schmaling cause a reduction in book value; therefore, the investment account is reduced by CCES in a corresponding manner

In addition, any excess amortization expense associated with the allocation of CCES's purchase price is recognized through a periodic adjustment By applying the equity method, both the income and investment balances maintained by the parent accurately reflect consolidated totals The equity method is especially helpful in monitoring the income of the business combination This method can be, however, rather difficult to apply and a time-consuming process

b The initial value method The initial value method can also be utilized by CCES

Corporation Any dividends received will be accounted for as income but no other investment entries are recorded Thus, the initial value method is quite easy to apply

However, the balances found within the parent's financial records may not provide a reasonable representation of the totals that will result from consolidating the two companies

c The partial equity method combines the advantages of the previous two techniques

Income is accrued as earned by the subsidiary in the same manner as the equity method Similarly, dividends are reported as a reduction in the investment account However, no other entries are recorded; more specifically, amortization is not recognized by the parent The method is, therefore, easier to apply than the equity method but the subsidiary's individual totals will still frequently approximate consolidated balances

2 a The consolidated total for equipment is made up of the sum of Maguire’s book value,

Williams’ book value, and any unamortized excess acquisition-date fair value over book value attributable to Williams’ equipment

b Although an Investment in Williams account is appropriately maintained by the parent, from a consolidation perspective the balance is intercompany in nature Thus, the entire amount will be eliminated in arriving at consolidated financial statements

c Only dividends paid to outside parties are included in consolidated statements Because Maguire owns 100 percent of Williams, all of the subsidiary's dividends are intercompany Consequently, only the dividends paid by the parent company will be reported in the financial statements for this business combination

d Any goodwill recognized within Maguire's original acquisition price must still be reported for consolidation purposes Reductions to the goodwill balance are made if goodwill is determined to be impaired

e Unless intercompany revenues have been recorded, consolidation is achieved in subsequent periods by adding the two book values together

f Consolidated expenses can be determined by adding the parent's book value to that

of the subsidiary and then including any amortization expense associated with the purchase price As will be discussed in detail in Chapter Five, intercompany expenses can also be present which require elimination in arriving at consolidated figures

g Only the common stock outstanding for the parent company is included in consolidated totals

h The net income for a business combination is calculated as the difference between consolidated revenues and consolidated expenses

3 When using the equity method, subsidiary earnings are accrued and amortization

expense (associated with the acquisition price in a purchase) is recognized in the same manner as in the consolidation process The equity method parallels consolidation Thus, the net income and retained earnings reported by the parent company each year will equal the consolidated totals

4 In the consolidation process, excess amortizations must be recorded annually for any

portion of the purchase price that is allocated to specific accounts (other than land or to

goodwill) Although this expense can be simulated in total on the parent's books by an equity method entry, the actual amortization of each allocated fair value adjustment is appropriate for consolidation Hence, the effect of the parent's equity method amortization entry is removed as part of Entry I so that the amortization of specific accounts (e.g., depreciation) can be recorded (in consolidation Entry E)

5 When the initial value method is applied by the parent company, no accrual is recorded

to reflect the subsidiary's change in book value during the years following acquisition Furthermore, recognition of excess amortizations relating to the acquisition price is also omitted by the parent The partial equity method, in contrast, records the subsidiary’s book value increases and decreases but not amortizations Consequently, for both of these methods, a technique must be established within the consolidation process to record the omitted figures Entry *C simply brings the parent's records (more specifically, the beginning retained earnings balance and the investment account) up-to-date as of the first day of the current year If the initial value method has been applied by the acquiring company, any changes in the subsidiary's book value in previous years must

be recorded on the worksheet along with the appropriate amount of amortization expense For the partial equity method, only the amortization relating to these prior years needs to be recognized

No similar entry is needed if the equity method has been applied; changes in the subsidiary's book value as well as excess amortization expense will be recorded each year by the parent Thus, under the equity method, the parent's investment and beginning retained earnings balances are both correctly established without further adjustment

6 Lambert's loan payable and the receivable held by Jenkins are intercompany accounts

As such, the reciprocal balances should be offset in the consolidation process The

$100,000 is not a debt to or a receivable from an unrelated (or outside) party and should, therefore, not be reported in consolidated financial statements Additionally any interest income/expense recognized on this loan is also intercompany in nature and must likewise be eliminated

7 Since the equity method has been applied by Benns, the $920,000 is composed of four

balances:

a The original consideration transferred by the parent;

b The annual accruals made by Benns to recognize income as it is earned by the subsidiary;

c The reductions that are created by the subsidiary's payment of dividends;

d The periodic amortization recognized by Benns in connection with the allocations identified with its purchase price

8 The $100,000 attributed to goodwill is reported at its original amount unless a portion of

goodwill is impaired or a unit of the business where goodwill resides is sold

9 A parent should consider recognizing an impairment loss for goodwill associated with a

purchased subsidiary when, at the reporting unit level, the fair value is less than its carrying amount Goodwill is reduced when its carrying value is less than its fair value

To compute fair value for goodwill, its implied value is calculated by subtracting the fair

values of the reporting unit’s identifiable net assets from its total fair value The impairment is recognized as a loss from continuing operations

10 The additional consideration is merely an extra component of the price paid by Remo to

purchase Albane Thus, any goodwill recognized at the original date of acquisition will be increased in 2009 by $100,000 However, if a bargain purchase occurred on January 1,

2009, this new payment reduces the allocations to noncurrent assets previously recognized for consolidation purposes

11 At present, the Securities and Exchange Commission requires the use of push-down

accounting for the separate financial statements of a subsidiary where no substantial

outside ownership exists Thus, if Company A owns all of Company B, the push-down method of accounting would be appropriate for the separately issued statements of Company B The SEC normally requires push-down accounting where 95 percent of a subsidiary is acquired and the company has no outstanding public debt or preferred stock

Push-down accounting may be required if 80-95 percent of the outstanding voting stock

is purchased Push-down accounting is justified in that the consideration transferred by the present owners is reported For example, if a piece of land costs Company B

$10,000 but Company A pays $13,000 for the land when acquiring Company B, the land has a basis to the current owners of B of $13,000 If B's financial records had been united with A at the time of the acquisition, the land would have been reported at

$13,000 Thus, leaving the $10,000 figure simply because separate incorporation is maintained is viewed, by proponents of push-down accounting, as unjustified

12 When push-down accounting is applied, the subsidiary adjusts the book value of its

assets and liabilities based on the allocations made at the date of the acquisition Periodic amortization expense is recognized subsequently by the subsidiary on each of these allocations (except for land) Therefore, the income recorded by the subsidiary is a fair representation of that company's impact on consolidated earnings

The parent uses no special procedures when push-down accounting is being applied However, if the equity method is in use, amortization need not be recognized by the parent since that expense is included in the figure reported by the subsidiary

13 Push-down accounting has become popular for the parent's internal reporting purposes

for two reasons First, this method simplifies the consolidation process each year If purchase price allocations and subsequent amortization are recorded by the subsidiary, they do not need to be repeated each year on a consolidation worksheet Second, recording of amortization by the subsidiary enables that company's information to provide a good representation of the impact that the acquisition has on the earnings of the business combination For example, if the subsidiary earns $100,000 each year but annual amortization is $80,000, the acquisition is only adding $20,000 to the income of the combination each year rather than the $100,000 that is reported by the subsidiary unless push-down accounting is used

Answers to Problems

1 A

2 B

3 A

4 D Willkom equipment book value—12/31/11 $210,000

Szabo book value—12/31/11 140,000

Original purchase price allocation to Szabo's equipment

11 C $60,000 allocation to equipment is "pushed-down" to subsidiary and

increases balance from $330,000 to $390,000 Consolidated balance is

$420,000 plus $390,000

12 (35 Minutes) (Determine consolidated retained earnings when parent uses various accounting methods Determine Entry *C for each of these methods)

a CONSOLIDATED RETAINED EARNINGS

Herbert (parent) balance—1/1/09 $400,000

Herbert income—2009 40,000

Herbert dividends—2009 (subsidiary dividends are

intercompany and, thus, eliminated) (10,000) Rambis income—2009 (not included in parent's income) 20,000

Amortization—2009 (12,000) Herbert income —2010 50,000

Herbert dividends—2010 (10,000) Rambis income—2010 30,000

Amortization—2010 (12,000) Consolidated Retained Earnings, 12/31/10 $496,000

Consolidated retained earnings are the same regardless of the method

in use: the beginning balance plus the income of the parent less the dividends of the parent plus the income of the subsidiary less

amortization expense Thus, consolidated retained earnings on

December 31, 2010 are $496,000 as computed above

b Investment in Rambis—Equity Method

Rambis fair value 1/1/09 $574,000 Rambis income 2009 20,000 Rambis dividends 2009 (5,000) Herbert’s 2009 excess fair over book value amortization (12,000) Investment account balance 1/1/10 $577,000 Investment in Rambis—Partial Equity Method

Rambis fair value 1/1/09 $574,000 Rambis income 2009 20,000 Rambis dividends 2009 (5,000) Investment account balance 1/1/10 $589,000 Investment in Rambis—Initial value method

Rambis fair value 1/1/09 $574,000 Investment account balance 1/1/10 $574,000

Amortization for the prior years (only 2009 in this case) has not been recorded and must be brought into the consolidation through

worksheet entry *C:

ENTRY *C

Retained Earnings, 1/1/10 (Parent) 12,000

Investment in Rambis 12,000 (To record 2009 amortization in consolidated figures Expense was omitted because of application of partial equity method.)

Amortization for the prior years (only 2009 in this case) has not been recorded and must be brought into the consolidation through

worksheet entry *C In addition, only dividend income has been

recorded by the parent ($5,000 in 2009) In this prior year, Rambis

reported net income of $20,000 Thus, the parent has not recorded the

$15,000 income in excess of dividends That amount must also be

included in the consolidation through entry *C:

ENTRY *C

Investment in Rambis 3,000

Retained Earnings, 1/1/10 (Parent) 3,000 (To record 2009 unrecognized subsidiary earnings as part of the

parent’s retained earnings $15,000 income of subsidiary was not

recorded by parent (income in excess of dividends) Amortization

expense of $12,000 was not recorded under the initial value method Note that *C adjustments bring the parent’s January 1, 2010 Retained Earnings balance equal to that of the equity method

13 (30 Minutes) (A variety of questions on equity method, initial value method, and partial equity method.)

a An allocation of the acquisition price (based on the fair value of the shares Issued) must be made first

Acquisition fair value (consideration paid by Haynes) $135,000 Book value equivalency (100,000) Excess of Turner fair value over book value $35,000

Equipment $5,000 5 yrs $1,000 Customer List 30,000 10 yrs 3,000

b Net income of Haynes $240,000 Net Income of Turner 130,000 Depreciation expense (1,000) Amortization expense (3,000) Consolidated net income 2010 $366,000

c Equipment balance Haynes $500,000 Equipment balance Turner 300,000 Allocation based on fair value (above) 5,000 Depreciation for 2009-2010 (2,000) Consolidated equipment—December 31, 2010 $803,000 Parent's choice of an investment method has no impact on consolidated totals

13 (continued)

d If the initial value method was applied during 2009, the parent would have recorded dividend income of $50,000 rather than $110,000 (as equity income) Income is, therefore, understated by $60,000 In

addition, amortization expense of $4,000 was not recorded Thus, the January 1, 2010, retained earnings is understated by $56,000 ($60,000 –

$4,000) An Entry *C is necessary on the worksheet to correct this equity figure:

Investment in Turner 56,000

Retained Earnings, 1/1/10 (Haynes) 56,000

If the partial equity method was applied during 2009, the parent would have failed to record amortization expense of $4,000 Retained earnings are overstated by $4,000 and are corrected through Entry *C:

Retained Earnings, 1/1/10 (Haynes) 4,000

Investment in Turner 4,000

If the equity method was applied during 2009, the parent's retained earnings are the same as the consolidated figure so that no adjustment

is necessary

14 (20 minutes) (Record a merger combination with subsequent testing for

Fair value of net assets acquired and

Entry by Francisco to record assets acquired and liabilities assumed in the combination with Beltran:

b Step one in goodwill impairment test:

Book value of reporting unit's net assets 1,585,000

Because the total fair value of the reporting unit is less than its carrying value,

a potential goodwill impairment loss exists, step two is performed:

Fair values of reporting unit's net assets (excluding goodwill) 1,325,000

15 (20 minutes) (Goodwill impairment testing.)

a Goodwill Impairment

Step 1

Because fair value < carrying value, there is a potential goodwill impairment loss

Step 2

Fair value of net assets excluding goodwill

16 (30 minutes) (Goodwill impairment and intangible assets.)

Part a

Goodwill Impairment Test—Step 1

Part b

Goodwill Impairment Test—Step 2 (Sand Dollar and Salty Dog only)

Fair values of identifiable net assets

Fair values of identifiable net assets

Part c

No changes in tangible assets or identifiable intangibles are reported based

on goodwill impairment testing The sole purpose of the valuation exercise

is to estimate an implied value for goodwill Destin will report a goodwill impairment loss of $20,000, which will reduce the amount of goodwill

allocated to Sand Dollar However, because the fair value of Sand Dollar’s trademarks is less than its carrying amount, the account should be

subjected to a separate impairment testing procedure to see if the carrying value is ―recoverable‖ in future estimated cash flows

17 (30 Minutes) (Consolidation entries for two years Parent uses equity

method.)

Fair Value Allocation and Annual Amortization:

Acquisition fair value (consideration paid) $490,000

Book value (assets minus

liabilities or total stockholders'

equity) (400,000)

Excess fair value over book value $90,000

Excess fair value assigned to specific

17 (continued)

Entry I

Equity in Subsidiary Earnings 74,000

Investment in Abernethy 74,000 (To eliminate $80,000 income accrual for 2009 less $6,000 amortization recorded by parent using equity method)

Entry D

Investment in Abernethy 10,000

Dividends Paid 10,000 (To eliminate intercompany dividend transfers)

Entry E

Depreciation expense 6,000

Equipment 4,000

Buildings 10,000 (To record 2009 amortization expense)

Consolidation Entries as of December 31, 2010

Retained Earnings account has been adjusted for 2009 income and dividends Entry *C is not needed because equity method was applied.)

amortizations for the prior period])

17 (continued)

Entry I

Equity in Subsidiary Earnings 104,000

Investment in Abernethy 104,000 (To eliminate $110,000 income accrual less $6,000 amortization recorded

by parent during 2010 using equity method)

Entry D

Investment in Abernethy 30,000

Dividends Paid 30,000 (To eliminate intercompany dividend transfers)

Entry E

Same as Entry E for 2009

18 (35 Minutes) (Consolidation entries for two years Parent uses initial value

method.)

Purchase Price Allocation and Annual Excess Amortizations:

Acquisition date value (consideration paid) $500,000

Book value (400,000)

Excess price paid over book value $100,000

acquisition-date fair values)

18 (continued)

Entry I

Dividend Income 10,000

Dividends Paid 10,000 (To eliminate intercompany dividend payments recorded by parent as income)

Entry E

Depreciation expense 4,000

Interest expense 7,500

Equipment 4,000 Long-term liabilities 7,500 (To record 2009 amortization expense)

Consolidation Entries as of December 31, 2010

Entry *C

Investment in Abernethy 58,500

(To convert parent company figures to equity method by recognizing subsidiary's increase in book value for prior year [$80,000 net income less $10,000 dividend payment] and excess amortizations for that period [$11,500])

subsidiary The retained earnings balance has been adjusted for 2009 income and dividends)

excess amortizations for the prior period])

Entry I

Dividend Income 30,000

Dividends Paid 30,000 (To eliminate intercompany dividend payments recorded by parent as income)

Entry E

Same as Entry E for 2009

19 (20 Minutes) (Consolidation entries for two years Parent uses partial equity

method.)

Fair Value Allocation and Annual Excess Amortizations:

Abernethy fair value (consideration paid) $520,000

Book value (400,000)

Excess fair value over book value (all goodwill) $120,000

Life assigned to goodwill Indefinite

Annual excess amortizations -0-

Consolidation Entries as of December 31, 2009

Entry A

Goodwill 120,000

Investment in Abernethy 120,000 (To recognize goodwill portion of the original acquisition fair value) Entry I

Equity in Earnings of Subsidiary 80,000

Investment in Abernethy 80,000 (To eliminate intercompany income accrual for the current year based

on the parent's usage of the partial equity method)

Entry D

Investment in Abernethy 10,000

Dividends Paid 10,000 (To eliminate intercompany dividend transfers)

Entry E—Not needed Goodwill is not amortized

Consolidation Entries as of December 31, 2010

Entry *C—Not needed Goodwill is not amortized

19 (continued)

(To eliminate beginning of year stockholders' equity accounts of

subsidiary—the retained earnings balance has been adjusted for 2009 Income and dividends.)

Entry A

Goodwill 120,000

Investment in Abernethy 120,000 (To recognize original goodwill balance.)

Entry I

Equity in Earnings of Subsidiary 110,000

Investment in Abernethy 110,000 (To eliminate Intercompany Income accrual for the current year.)

Entry D

Investment in Abernethy 30,000

Dividends Paid 30,000 (To eliminate Intercompany dividend transfers.)

Equity E—not needed

20 (45 Minutes) (Variety of questions about the three methods of recording an

Investment in a subsidiary for internal reporting purposes.)

a Purchase Price Allocation and Annual Amortization:

Hamilton’s acquisition-date fair value $510,000

Book value (assets minus liabilities

or stockholders' equity) 450,000

Fair value in excess of book value 60,000 Annual Excess

difference between fair value and

book value 50,000 5 yrs $10,000 Goodwill $10,000 indefinite -0- Total $10,000

EQUITY METHOD

Investment Income—2010:

Amortization (above) (10,000) Total $50,000

Equity accrual 60,000 Excess amortizations (10,000) Dividends received -0- Total $600,000

PARTIAL EQUITY METHOD

Investment Income—2010:

Equity accrual $60,000 Investment in Hamilton—December 31, 2010:

Consideration transferred for Hamilton $510,000 2009:

Equity accrual (based on Hamilton's Income) 55,000 Dividends received (5,000) 2010:

Equity accrual 60,000 Dividends received -0- Total $620,000

Consideration transferred for Hamilton $510,000

b The consolidated account balances are not affected by the method of recording used by the parent Thus, consolidated Expenses ($480,000 or

$290,000 + $180,000 + amortizations of $10,000) are the same regardless

of whether the equity method, the partial equity method, or the initial value method is applied by Jefferson

c The consolidated account balances are not affected by the method of recording used by the parent Thus, consolidated Equipment ($970,000

or $520,000 + $420,000 + allocation of $50,000 – two years of excess depreciation of $20,000) is the same regardless of whether the equity method, the partial equity method, or the initial value method is applied

by Jefferson

d Jefferson Retained Earnings —Equity Method

Jefferson Retained Earnings—1/1/09 $860,000 Jefferson income 2009 (400,000 – 290,000) 110,000

2009 equity accrual for Hamilton income 55,000

2009 excess amortization (10,000) Jefferson Retained Earnings—1/1/10 $1,015,000

Jefferson Retained Earnings—Partial Equity Method

Jefferson Retained Earnings—Initial value method

Jefferson Retained Earnings—1/1/09 $860,000 Jefferson income 2009 (400,000 – 290,000) 110,000

2009 dividend income from Hamilton 5,000 Jefferson Retained Earnings—1/1/10 $975,000

20 (continued)

e EQUITY METHOD —Entry *C is not utilized since parent's retained

earnings balance is correct

PARTIAL EQUITY METHOD—Entry *C is needed to record amortization

for prior year

Retained earnings, 1/1/10 (parent) 10,000

Investment in Hamilton 10,000

INITIAL VALUE METHOD—Entry *C is needed to record increase in

subsidiary's book value ($50,000) and amortization ($10,000) for prior year

Investment in Hamilton 40,000

Retained earnings, 1/1/10 (parent) 40,000

f Entry S is not affected by the method used by the parent to record the Investment in Hamilton Under each of these three methods, the

following Entry S would be appropriate for 2010:

Common stock (Hamilton) 150,000 Retained earnings, 1/1/10 (Hamilton) 350,000 Investment in Hamilton 500,000

g Consolidated revenues (add the two book values) $640,000 Consolidated expenses (add the two book values

and excess amortizations) (480,000) Consolidated net income $160,000

21 (15 Minutes) (Consolidated accounts one year after acquisition)

Stanza acquisition fair value ($10,000 in

stock issue costs reduce additional paid-in capital) $680,000 Book value of subsidiary

(1/1/10 stockholders' equity balances) (480,000)

Fair value in excess of book value $200,000

Excess fair value allocated to copyrights Life Amortizations

based on fair value 120,000 6 yrs $20,000 Goodwill $80,000 indefinite -0- Total $20,000

a Consolidated copyrights

Penske (book value) $900,000 Stanza (book value) 400,000 Allocation (above) 120,000 Excess amortizations, 2010 (20,000) Total $1,400,000

Annual Excess

21 (continued)

b Consolidated net income, 2010

Revenues (add book values) $1,100,000 Expenses:

Add book values $700,000 Excess amortizations 20,000 720,000 Consolidated net income $380,000

c Consolidated retained earnings, 12/31/10

Retained earnings 1/1/10 (Penske) $600,000 Net income 2010 (above) 380,000 Dividends paid 2010 (Penske) (80,000) Total $900,000

Stanza's retained earnings balance as of January 1, 2010, is not included because these operations occurred prior to the purchase Stanza's dividends were paid to Penske and therefore are excluded because they are intercompany in nature

d Consolidated goodwill, 12/31/10

Allocation (above) $80,000

22 (30 Minutes) (Consolidated balances three years after the date of

acquisition Includes questions about parent's method of recording

investment for internal reporting purposes.)

a Acquisition-Date Fair Value Allocation and Amortization:

Consideration transferred 1/1/09 $600,000

Book value (given) (470,000) Annual

Fair value in excess of book value 130,000 Excess

difference in fair value and book value 90,000 10 yrs $9,000 Goodwill $40,000 indefinite -0- Total $9,000

CONSOLIDATED BALANCES

 Depreciation expense = $659,000 (book values plus $9,000 excess depreciation)

 Dividends Paid = $120,000 (parent balance only Subsidiary's

dividends are eliminated as intercompany transfer)

 Revenues = $1,400,000 (add book values)

 Equipment = $1,563,000 (add book values plus $90,000 allocation less three years of excess depreciation [$27,000])

22 (continued)

 Buildings = $1,200,000 (add book values)

 Goodwill = $40,000 (original residual allocation)

 Common Stock = $900,000 (parent balance only)

b The parent's choice of an investment method has no impact on the consolidated totals The choice of an investment method only affects the internal reporting of the parent

c The initial value method is used The parent's Investment in Subsidiary account still retains the original consideration transferred of $600,000

In addition, the Investment Income account equals the amount of

dividends paid by the subsidiary

d If the partial equity method had been utilized, the investment income account would have shown an equity accrual of $100,000 If the equity method had been applied, the Investment Income account would have included both the equity accrual of $100,000 and excess amortizations

of $9,000 for a balance of $91,000

e Initial Value Method —Foxx’s Retained Earnings—1/1/11

Foxx’s 1/1/11 balance (initial value method was employed) $1,100,000

Partial Equity Method—Foxx’s Retained Earnings—1/1/11

Foxx’s 1/1/11 balance (initial value method) $1,100,000

2009 net equity accrual for Greenburg (90,000 – 20,000) 70,000

2010 net equity accrual for Greenburg (100,000 – 20,000) 80,000 Foxx’s 1/1/11 Retained Earnings $1,250,000

Equity Method—Foxx’s Retained Earnings—1/1/11

Foxx’s 1/1/11 balance (initial value method) $1,100,000

2009 net equity accrual for Greenburg (90,000 – 20,000) 70,000

2009 excess fair over book value amortization (9,000)

2010 net equity accrual for Greenburg (100,000 – 20,000) 80,000

2010 excess fair over book value amortization (9,000) Foxx’s 1/1/11 Retained Earnings $1,232,000

23 (50 Minutes) (Consolidated totals for a purchase Worksheet is produced as

a separate requirement.)

a O’Brien acquisition-date fair value $550,000

O’Brien book value (350,000)

Fair value in excess of book value $200,000

23 (continued)

Amortizations

Trademarks 100,000 indefinite -0- Customer relationships 75,000 5 yrs $15,000 Equipment (30,000) 10 yrs (3,000) Goodwill 55,000 indefinite -0- Total $200,000 $12,000

If the partial equity method were in use, the Income of O’Brien account would have had a balance of $222,000 (100% of O’Brien's reported income for the period) If the initial value method were in use, the Income of O’Brien account would have had a balance of $80,000 (100% of the dividends paid by O’Brien) Thus, the equity method must be in use The Income of O’Brien balance is an equity accrual of $222,000 (100% of O’Brien’s reported income) less excess amortizations of $12,000 (as computed above)

b Students can develop consolidated figures conceptually, without relying on a worksheet or consolidation entries Thus, part b asks students to determine independently each balance to be reported by the business combination

 Revenues = $1,645,000 (the accounts of both companies combined)

 Cost of Goods Sold = 528,000 (the accounts of both companies combined)

 Amortization Expense = $40,000 (the accounts of both companies and the acquisition-related adjustment of $15,000)

 Depreciation Expense = $142,000 (the accounts for both companies and the

acquisition-related depreciation adjustment of $3,000)

replaced with the subsidiary’s individual revenue and expense accounts)

 Net Income = 935,000 (consolidated revenues less expenses)

 Retained Earnings, 1/1 = $700,000 (only the parent's retained earnings

figure is included)

 Dividends Paid = $142,000 (the subsidiary's dividends were paid to the

parent and, thus, as an intercompany transfer are eliminated)

 Retained Earnings, 12/31 = $1,493,000 (the beginning balance for the parent

plus consolidated net income less consolidated [parent] dividends)

 Cash = $290,000 (the accounts of both companies are added together)

 Receivables = $281,000 (the accounts of both companies are combined)

 Inventory = $310,000 (the accounts of both companies are combined)

23 (continued)

with the subsidiary’s individual asset and liability accounts)

 Trademarks = $634,000 (the accounts of both companies are added

together plus the 100,000 fair value adjustment)

 Customer relationships = $60,000 (the initial $75,000 fair value adjustment

less $15,000 amortization expense)

value adjustment net of $3,000 in depreciation expense reduction)

 Goodwill = $55,000 (the original allocation)

 Total Assets = $2,800,000 (summation of consolidated balances)

 Liabilities = $907,000 (the accounts of both companies are combined)

 Common Stock = $400,000 (parent balance only)

 Retained Earnings, 12/31 = $1,493,000 (computed above)

 Total Liabilities and Equities = 2,800,000 (summation of consolidated

balances)

23 (Continued)

Consolidation Worksheet For Year Ending December 31

Consolidation Entries Consolidated

24 (60 Minutes) (Consolidation worksheet five years after acquisition with

parent using initial value method Effects of using equity method also

included)

Acquisition-Date Fair Value Allocation and Annual Amortization:

a Aaron fair value (stock exchanged

at fair value) $470,000 Book value of subsidiary (360,000)

Excess fair value over book value $110,000

Excess assigned to specific

consolidation

Aaron' retained earnings January 1, 2013 $490,000 Retained earnings at date of purchase (230,000) Increase since date of purchase $260,000 Excess amortization expenses ($15,000 x 4 years) (60,000) Conversion to equity method for years prior to 2013

(Entry *C) $200,000

Explanation of Consolidation Entries Found on Worksheet

Entry*C: Converts 1/1/13 figures from initial value method to equity

method as per computation above

Entry S: Eliminates stockholders' equity accounts of subsidiary as of

the beginning of current year

Entry A: Recognizes allocations to royalty agreements and trademark

This entry establishes unamortized balances as of the beginning of the current year

Entry I: Eliminates intercompany dividends

Entry E: Records excess amortization expenses for the current year

See next page for worksheet

24 a (continued)

MICHAEL COMPANY AND CONSOLIDATED SUBSIDIARY

Consolidation Worksheet For Year Ending December 31, 2013

Consolidation Entries Consolidated

Dividend income (5,000) -0- (I) 5,000 - 0

Trademark - 0 - - 0 - (A) 30,000 (E) 5,000 25,000

Parentheses indicate a credit balance

24 (continued)

b If the equity method had been applied by Michael, three figures on that company's financial records would be different: Equity in Earnings of Aaron, Retained Earnings—1/1/13, and Investment in Aaron Co

Equity in Earnings of Aaron: $135,000 (the parent would accrue 100% of Aaron's $150,000 income but must also recognize $15,000 in

amortization expense.)

Retained Earnings, 1/1/13: $1,080,000 (increases by $200,000—the

parent would have recognized the $260,000 increment in the

subsidiary's book value during previous years as well as $60,000 in excess amortization expenses for these same four years [see Part a.]) Investment in Aaron: $800,000 (increases by $330,000—the parent would have recognized the $260,000 increment in the subsidiary's book value during previous years as well as $60,000 in excess amortization

expenses for these same four years [see Part a.] In the current year, income of $135,000 would have been recognized [see above] along with

a reduction of $5,000 for dividends received)

c No Entry *C is needed on the worksheet if the equity method is applied Both the investment account as well as beginning retained earnings would be stated appropriately

Entry I would have been used to eliminate the $135,000 Equity in

Earnings of Aaron from the parent's income statement and from the Investment in Aaron Co account

Entry D would eliminate the $5,000 current year dividend from Dividends Paid and the Investment in Aaron account balances

d Consolidated figures are not affected by the investment method used by the parent The parent company balances would differ and changes would be required in the worksheet entries However, the figures to be reported do not depend on the parent's selection of a method

25 (65 Minutes) (Consolidated totals and worksheet five years after

acquisition Parent uses equity method Includes goodwill impairment.)

a Acquisition-date fair value allocations (given) Life Excess

The problem states that the equity method is in use Thus, the $135,000

"Equity in Income of Small" would be comprised of a $140,000 equity accrual (100% of the subsidiary's reported earnings) less $5,000 in

amortization expense computed above

b

 Revenues = $1,535,000 (both balances are added together)

 Cost of Goods Sold = $640,000 (both balances are added)

 Depreciation Expense = $307,000 (both balances are added along with excess equipment depreciation)

 Equity in Income of Small = $0 (the parent's income balance is removed

and replaced with Small's individual revenue and expense accounts)

 Net Income = $588,000 (consolidated expenses are subtracted from

consolidated revenues)

 Dividends Paid = $310,000 (the parent number alone because the

subsidiary's dividends are intercompany, paid to Giant)

beginning of the year plus consolidated net income less consolidated dividends paid)

 Current Assets = $706,000 (both book balances are added together while

the $10,000 intercompany receivable is eliminated)

 Investment in Small = $0 (the parent's asset is removed so that Small's

individual asset and liability accounts can be brought into the

consolidation)

 Land = $695,000 (both book balances are added together along with the

purchase price allocation of $90,000)

 Buildings = $723,000 (both book balances are added together)

 Equipment = $959,000 (both book balances are added plus the

unamortized portion of the purchase price allocation [$50,000 less

$25,000 after 5 years of excess depreciation])

25 b (continued)

 Goodwill = $60,000 (represents the original price allocation)

 Total Assets = $3,143,000 (summation of all consolidated assets)

 Liabilities = $1,198,000 (both balances are added together while the

$10,000 intercompany payable is eliminated)

 Common Stock = $250,000 (parent balance only)

 Retained Earnings, 12/31/13 = $1,695,000 (see above)

 Total Liabilities and Equity = $3,143,000 (summation of all

consolidated liabilities and equity)

c Worksheet is presented on following page

d If all goodwill from the Small investment was determined to be impaired, Giant would make the following journal entry on its books:

After this entry, the worksheet process would no longer require an

adjustment in Entry (A) to recognize goodwill The impairment loss would simply carry over to the consolidated income column The impairment loss would be reported as a separate line item in the operating section of the consolidated income statement