Solution manual advanced accounting 11th edition joe ben hoyle chap003

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 (sometimes referred to as the cost method)

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 subsequent to the acquisition date, certain procedures are required If

the parent applies 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 value 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 intra-entity dividend payments

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

f Entry P eliminates any intra-entity 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 intra-entity 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 subsidiary 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 excess 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 The parent recognizes an excess of net asset fair value over the consideration transferred as a “gain on bargain purchase.”

V Goodwill Impairment

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 at least qualitatively assessed for impairment annually If there are indicators of goodwill impairment, then without undergoing a qualitative assessment, goodwill should be tested for impairment at least annually.

3 Interim impairment testing is 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 should 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 FASB permits an option to perform a qualitative analysis to assess whether further testing procedures are appropriate The analysis includes determining whether it is more likely than not (a probability of more than 50 percent) that goodwill is impaired If this likelihood is not judged to be attained, then no further testing is required.

3 If circumstances, or the qualitative analysis, indicate a possible decline in the fair value of a reporting unit below its carrying value, then goodwill is tested for impairment using a two-step approach.

a The first step 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.

4 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?

1 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.

2 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 Contingent consideration

A The fair value of any contingent consideration is included as part of the consideration transferred

B If the contingency results in a liability (typically a cash payment), changes in the fair value of the contingency are recognized in income as they occur.

C If the contingency calls for an additional equity issue at a later date, the date fair value of the contingency is not adjusted over time Any subsequent shares issued as a consequence of the contingency are recorded at the original acquisition- date fair value This treatment is similar to other equity issues (e.g., common stock, preferred stock, etc.) in the parent’s owners’ equity section.

acquisition-VII Push-down accounting

A A subsidiary may record any acquisition-date fair value allocations directly in its own financial records rather than through the use of a worksheet Subsequent amortization expense of 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.

Answers to Discussion Questions

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

Students can come up with dozens of factors that Pilgrim should consider in choosing its internal method of accounting for its subsidiary, Crestwood Corporation The following is only a partial list of possible points to consider.

 Use of the information If Pilgrim does not monitor its subsidiary’s income levels closely, applying the equity method may be not be fruitful A company must plan to use the data before the task of accumulation becomes worthwhile For example, Crestwood may use the information for evaluating the performance of the subsidiary’s managers.

 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 distributes most of its income 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, its annual amortization charges are high, and use of the equity method might be preferred to show the amortization effect each reporting period In this case, waiting until year end 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 intra-entity transactions As with amortization, the volume of transfers can be an important element in deciding which accounting method to use If few intra-entity 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 easy 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 its

Investment in Schmaling Under this approach, the parent's records parallel the activities of the subsidiary The parent accrues income as it is earned by the subsidiary Dividends paid by Schmaling reduce its book value; therefore, CCES reduces the investment account In addition, any excess amortization expense associated CCES's acquisition-date fair value allocations is recognized through a periodic adjustment By applying the equity method, both the parent’s income and investment balances 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 are recognized as income but no other investment entries are made Thus, the initial value method is easy to apply However, the resulting account balances of the parent may not provide a reasonable representation of the totals that 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 as under the equity method Similarly, dividends reduce 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 intra-entity in nature Thus, the entire amount is 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 intra-entity Consequently, only the dividends paid by the parent company will be reported in the financial statements for this business combination.

d Any acquisition-date goodwill must still be reported for consolidation purposes Reductions to goodwill are made if goodwill is determined to be impaired

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

f Consolidated expenses are determined by combining the parent's and subsidiary amounts and then including any amortization expense associated with the acquisition-date fair value allocations As will be discussed in detail in Chapter Five, intra-entity expenses can also be present which require elimination in arriving at consolidated figures.

g Only the parent’s common stock outstanding 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 Under the equity method, the parent accrues subsidiary earnings and amortization

expense (from allocation of acquisition-date fair values) in the same manner as in the consolidation process The equity method parallels consolidation Thus, the parent’s net income and retained earnings 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 opr other indefinite-lived assets) 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 a parent applies the initial value method, no accrual is recorded to reflect the

subsidiary's change in book value subsequent to acquisition Recognition of excess amortizations relating to the acquisition 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 employed in 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 acquirer applies the initial value method, changes in the subsidiary's book value in previous years are recognized 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 to *C is needed when the parent applies the equity method The parent will record changes in the subsidiary's book value as well as excess amortization each year Thus, under the equity method, the parent's investment and beginning retained earnings balances are both correctly established and need no further adjustment.

6 Lambert's loan payable and the receivable held by Jenkins are intra-entity accounts.

The consolidation process offsets these reciprocal balances The $100,000 is neither a debt to nor a receivable from an unrelated (or outside) party and is, therefore, not reported in consolidated financial statements Any interest income/expense recognized

on this loan is also intra-entity in nature and must likewise be eliminated.

7 Because Benns applies the equity method, 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 subsidiary income as it is earned

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

d The periodic amortization recognized by Benns in connection with the identified acquisition-date fair value allocations.

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

subsidiary when, at the reporting unit level, the fair value is less than its carrying amount A firm has the option to perform a qualitative assessment of whether a reporting unit’s fair value is more likely than not to be less than its carrying value before proceeding to the quantitative 2-step goodwill impairment testing procedure Goodwill is reduced when its carrying value is less than its implied fair value To compute an implied fair value for goodwill, the fair values of the reporting unit’s identifiable net assets are subtracted from its total fair value The impairment is recognized as a loss from continuing operations.

10 The acquisition-date fair value of the contingent payment is part of the consideration

transferred by Reimers to acquire Rollins and thus is part of the overall fair value assigned to the acquisition If the contingency is a liability (to be settled in cash or other assets) then the liability is adjusted to fair value through time If the contingency is a component of equity (e.g., to be settled by the parent issuing equity shares), then the equity instrument is not adjusted to fair value over time.

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 is 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 acquired Push-down accounting uses the consideration transferred as the valuation basis for the subsidiary in consolidated reports For example, if a piece of land costs Company B $10,000 but Company A allocates a $13,000 fair value to the land in 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, keeping 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 acquisition-date fair value allocations The subsidiary then recognizes periodic amortization expense on those allocations with definite lives Therefore, the subsidiary’s recorded income equals its 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.

Answers to Problems

1 A

2 B

3 A

4 D Willkom’s equipment book value—12/31/13 $210,000

Szabo’s equipment book value—12/31/13 140,000

Original purchase price allocation to Szabo's equipment

-or-Consolidated revenues $783,000

Consolidated expenses (includes $35K amortization) 580,000

10 A (same as Phoenix because of equity method use).

Three years since acquisition, ¼ of acquisition-date value ($25,000)remains.

12 B

13 C

14.C The $60,000 excess acquisition-date fair value allocation to equipment is

"pushed-down" to the subsidiary and increases its balance to $390,000 The consolidated balance is $810,000 ($420,000 plus $390,000).

15 (35 Minutes) (Determine consolidated retained earnings when parent uses various accounting methods Determine Entry *C for each of these methods)

a CONSOLIDATED RETAINED EARNINGS EQUITY METHOD

Herbert (parent) balance—1/1/12 $400,000 Herbert income—2012 40,000 Herbert dividends—2012 (subsidiary dividends are

intercompany and, thus, eliminated) (10,000) Rambis income—2012 (not included in parent's income) 20,000 Amortization—2012 (12,000) Herbert income—2013 50,000 Herbert dividends—2013 (10,000) Rambis income—2013 30,000 Amortization—2013 (12,000) Consolidated retained earnings, 12/31/13 $496,000

Consolidated retained earnings are the same regardless of the method

in use: the beginning balance plus the income less the dividends of the parent plus the income of the subsidiary less amortization expense Thus, December 31, 2013 consolidated retained earnings are $496,000

as computed above.

b Investment in Rambis—equity method

Rambis fair value 1/1/12 $574,000 Rambis income 2012 20,000 Rambis dividends 2012 (5,000) Herbert’s 2012 excess fair over book value amortization (12,000) Investment account balance 1/1/13 $577,000 Investment in Rambis—partial equity method

Rambis fair value 1/1/12 $574,000 Rambis income 2012 20,000 Rambis dividends 2012 (5,000) Investment account balance 1/1/12 $589,000 Investment in Rambis—Initial value method

Rambis fair value 1/1/12 $574,000 Investment account balance 1/1/13 $574,000

Amortization for the prior years (only 2012 in this case) has not been recorded and must be brought into the consolidation through

worksheet entry *C:

ENTRY *C

Retained Earnings, 1/1/13 (Parent) 12,000

Investment in Rambis 12,000 (To record 2012 amortization in consolidated figures Expense was omitted because of application of partial equity method.)

Amortization for the prior years (only 2012 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 2012) 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:

Note that *C adjustments bring the parent’s January 1, 2013 Retained Earnings balance equal to that of the equity method.

16 (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 2013 $366,000

c Equipment balance Haynes $500,000 Equipment balance Turner 300,000 Allocation based on fair value (above) 5,000 Depreciation for 2012-2013 (2,000) Consolidated equipment—December 31, 2013 $803,000 Parent's choice of an investment method has no impact on consolidated totals.

16 (continued)

d If the initial value method was applied during 2012, the parent would have recorded dividend income of $50,000 rather than $110,000 (as equity income) Net income is, therefore, understated by $60,000 In addition, amortization expense of $4,000 was not recorded Thus, the January 1, 2013, 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

If the partial equity method was applied during 2012, 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, 1/1/13 (Haynes) 4,000

Consideration transferred (above) $1,698,000

Fair value of net assets acquired and

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

Common stock (Francisco Co., par value) 104,000

b Step one in quantitative 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

18 (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

-0-19 (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

Carrying value of goodwill 150,000

-0-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.

20 (30 Minutes) (Consolidation entries for two years Parent uses equity

method.)

Fair Value Allocation and Annual Amortization:

Acquisition fair value (consideration transferred) $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

Entry I

Equity in Earnings of Subsidiary 74,000

Investment in Abernethy 74,000 (To eliminate $80,000 income accrual for 2012 less $6,000 amortization recorded by parent using equity method)

20 (continued)

Entry D

Investment in Abernethy 10,000

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

Entry E

Depreciation Expense 6,000

Equipment 4,000

Buildings 10,000 (To record current year amortization expense)

Consolidation Entries as of December 31, 2013

Retained Earnings account has been adjusted for 2012 income and dividends Entry *C is not needed because equity method was applied.) Entry A

Land 10,000

Buildings 30,000

Goodwill 60,000

Equipment 16,000 Investment in Abernethy 84,000

(To recognize allocations relating to investment—balances shown here are as of beginning of current year [original allocation less excess amortizations for the prior period])

Entry I

Equity in Earnings of Subsidiary 104,000

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

by parent during 2013 using equity method)

Entry D

Investment in Abernethy 30,000

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

Entry E

Same as Entry E for 2012

21 (35 Minutes) (Consolidation entries for two years Parent uses initial value

method.)

Purchase price allocation and annual excess fair value amortizations:

Acquisition date value (consideration paid) $500,000

Book value (400,000)

Excess price paid over book value $100,000

(To recognize allocations determined above in connection with

acquisition-date fair values)

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 2012 amortization expense)

21 (continued)

Consolidation Entries as of December 31, 2013

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 2012 income and dividends)

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 2012

22 (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, 2012

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

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

Entry E—Not needed Goodwill is not amortized.

Consolidation Entries as of December 31, 2013

Entry *C—Not needed Goodwill is not amortized.

Entry S

Common Stock—Abernethy 250,000

Additional Paid-in Capital—Abernethy 50,000

Retained Earnings —Abernethy—1/1/13 170,000

Investment in Abernethy 470,000

22 (continued)

(To eliminate beginning of year stockholders' equity accounts of

subsidiary—the retained earnings balance has been adjusted for 2012 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

23 (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:

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

Equity accrual (based on Clay's Income) 60,000 Excess amortizations (10,000) Dividends received (8,000 ) Total $592,000

23 (continued)

INITIAL VALUE METHOD

Investment Income—2013:

Dividend income $8,000 Investment in Clay—December 31, 2013:

Consideration transferred for Clay $510,000

b Consolidated balances are not affected by the parent’s investment accounting method Thus, consolidated expenses ($480,000 or $290,000 + $180,000 + amortizations of $10,000) are the same regardless of

whether Adams uses the equity method or the initial value method.

c Consolidated balances are not affected by the parent’s investment accounting method Thus, consolidated equipment ($970,000 or

$520,000 + $420,000 + allocation of $50,000 – two years of excess

depreciation totaling $20,000) is the same regardless of whether the equity method or the initial value method is applied by Adams.

d Adams retained earnings—Equity method

Adams retained earnings—1/1/12 $860,000 Adams income 2012 125,000

2012 equity in earnings of Clay (above) 45,000 Adams retained earnings—1/1/13 $1,030,000

Adams retained earnings—Initial value method

Adams retained earnings—1/1/12 $860,000 Adams income 2012 125,000

2012 dividend income from Clay 5,000 Adams retained earnings—1/1/13 $990,000

e EQUITY METHOD—Entry *C is unnecessary because the parent's

retained earnings balance is correct.

INITIAL VALUE METHOD—Entry *C recognizes the increase in

subsidiary's book value ($55,000 income less 5,000 dividends) and amortization ($10,000) for prior year.

Investment in Clay 40,000

Retained Earnings, 1/1/13 (parent) 40,000

f Consolidated worksheet entry S for 2013:

Common Stock (Clay) 150,000 Retained Earnings, 1/1/13 (Clay) 350,000 Investment in Clay 500,000

23 (continued)

g Consolidated revenues (combined) $640,000 Consolidated expenses (combined plus

excess amortization) (480,000) Consolidated net income $160,000

24 (15 Minutes) (Consolidated accounts one year after acquisition)

Stanza acquisition fair value ($10,000 in

stock issue costs reduce APIC $680,000 Book value of subsidiary

(1/1/13 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, 2013 (20,000) Total $1,400,000

b Consolidated net income, 2013

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

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

c Consolidated retained earnings, 12/31/13

Retained Earnings 1/1/13 (Penske) $600,000 Net income 2013 (above) 380,000 Dividend Paid 2013 (Penske) (80,000) Total $900,000 Stanza's January 1, 2013 retained earnings balance, is not included because they represent pre-acquisition earnings Stanza's dividends paid to Penske are excluded because they are intra-entity in nature.

d Consolidated goodwill, 12/31/13

Allocation (above) $80,000

Annual excess

25 (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 1/1/11 $600,000

Book value (given) (470,000) Annual

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)

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

dividends are eliminated as intra-entity 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])

 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—1/1/13

Foxx’s 1/1/13 balance (initial value method was employed) $1,100,000

Partial equity method—Foxx’s retained earnings—1/1/13

25 (continued)

Foxx’s 1/1/13 balance (initial value method) $1,100,000

2011 net equity accrual for Greenburg ($90,000 – $20,000) 70,000

2012 net equity accrual for Greenburg ($100,000 – $20,000) 80,000 Foxx’s 1/1/13 retained earnings $1,250,000

Equity method—Foxx’s retained earnings—1/1/13

Foxx’s 1/1/13 balance (initial value method) $1,100,000

2011 net equity accrual for Greenburg ($90,000 – $20,000) 70,000

2011 excess fair over book value amortization (9,000)

2012 net equity accrual for Greenburg ($100,000 – $20,000) 80,000

2012 excess fair over book value amortization (9,000) Foxx’s 1/1/13 retained earnings $1,232,000

26 (50 Minutes) (Consolidated totals for an acquisition 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

amortizations

Trademarks $100,000 indefinite 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

-0-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) 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) Thus, the equity method must be in use.

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)

26 (continued)

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

acquisition-related depreciation adjustment of $3,000)

 Income of O’Brien = $0 (the balance reported by the parent is removed and

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)

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

parent and, thus, as an intra-entity 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)

 Investment in O’Brien = $0 (the parent’s balance is removed and replaced 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)

 Equipment = $1,170,000 (both company’s balances less the $30,000 fair

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)

26 (Continued)

Consolidation Worksheet For Year Ending December 31

Consolidation Entries Consolidated

Retained earnings (above) (1,493,000) (392,000) (1,493,000)

27 (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's retained earnings January 1, 2013 $490,000 Retained earnings at date of acquisition (230,000) Increase since date of acquisition $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

Explanations of consolidation worksheet entries

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 intra-entity dividends.

Entry E: Records excess amortization expenses for the current year.

See next page for worksheet.

27 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.

27 (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.

28 (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 Annual excess

Because Giant uses the equity method, the $135,000 "Equity in Income

of Small" reflects a $140,000 equity accrual (100% of Small’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)

 Retained earnings, 1/1/13 = $1,417,000 (the parent’s balance)

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

subsidiary's dividends are intra-entity, paid to Giant)

 Retained earnings, 12/31/13 = $1,695,000 (the parent’s balance at

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 intra-entity 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

acquisition-date fair value 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 acquisition-date fair value allocation [$50,000 less $25,000 after 5 years of excess depreciation])