Advanced accounting, 5th edition international student version ch05

55 Allocation and Depreciation of Differences Between Implied and Book Values Acquisition Advanced Accounting, Fifth Edition Slide 5-1 Learning Learning Objectives Objectives Slide 5-2 Calculate the difference between implied and book values and allocate to the subsidiary’s assets and liabilities Describe FASB’s position on accounting for bargain acquisitions Explain how goodwill is measured at the time of the acquisition Describe how the allocation process differs if less than 100% of the subsidiary is acquired Record the entries needed on the parent’s books to account for the investment under the three methods: the cost, the partial equity, and the complete equity methods Prepare workpapers for the year of acquisition and the year(s) subsequent to the acquisition, assuming that the parent accounts for the investment using the cost, the partial equity, and the complete equity methods Understand the allocation of the difference between implied and book values to long-term debt components Explain how to allocate the difference between implied and book values when some assets have fair values below book values Distinguish between recording the subsidiary depreciable assets at net versus gross fair values 10 Understand the concept of push down accounting Allocation Allocation of of Difference Difference Between Between Implied Implied and and Book Book Values: Values: Acquisition Acquisition Date Date When consolidated financial statements are prepared, asset and liability values must be adjusted by allocating the difference between implied and book values to specific recorded or unrecorded tangible and intangible assets and liabilities In the case of a wholly owned subsidiary, the implied value of the subsidiary equals the acquisition price Slide 5-3 LO Computation and Allocation of Difference Allocation Allocation of of Difference Difference Between Between Implied Implied and and Book Book Values: Values: Acquisition Acquisition Date Date Allocation of difference between implied and book values at date of acquisition - wholly owned subsidiary Step 1: Difference used first to adjust the individual assets and liabilities to their fair values on the date of acquisition Step 2: Any residual amount:  Implied value > aggregate fair values = goodwill  Implied value < aggregate fair values = bargain Bargain is recognized as an ordinary gain Slide 5-4 LO Computation and Allocation of Difference Allocation Allocation of of Difference Difference Between Between Implied Implied and and Book Book Values: Values: Acquisition Acquisition Date Date Bargain Rules under prior GAAP (before 2007 standard): Acquired assets, except investments accounted for by the equity method, are recorded at fair market value Previously recorded goodwill is eliminated Long-lived assets (including in-process R&D and excluding long-term investments) are recorded at fair market value minus an adjustment for the bargain Extraordinary gain recorded if all long-lived assets are reduced to zero • Slide 5-5 Current GAAP eliminates these rules and requires an ordinary gain to be recognized instead LO FASB’s position on accounting for bargain acquisitions Allocation Allocation of of Difference Difference Between Between Implied Implied and and Book Book Values: Values: Acquisition Acquisition Date Date Bargain Rules: When a bargain acquisition occurs, under FASB ASC paragraph 805-30-25-2, the negative (or credit) balance should be recognized as an ordinary gain in the year of acquisition No assets should be recorded below their fair values Note: A true bargain is not likely to occur except in situations where nonquantitative factors play a role Slide 5-6 LO FASB’s position on accounting for bargain acquisitions Allocation Allocation of of Difference Difference Between Between Implied Implied and and Book Book Values: Values: Acquisition Acquisition Date Date Review Question In the event of a bargain acquisition (after carefully considering the fair valuation of all subsidiary assets and liabilities) the FASB requires the following accounting: a an ordinary gain is reported in the financial statements of the consolidated entity b an ordinary loss is reported in the financial statements of the consolidated entity c negative goodwill is reported on the balance sheet Slide 5-7 LO 2are FASB’s position on accounting for bargain acquisitions d assets written down to zero value, if needed Allocation Allocation of of Difference Difference Case 1: Implied Value “in Excess of” Fair Value E5-1: On January 1, 2010, Pam Company purchased an 85% interest in Shaw Company for $540,000 On this date, Shaw Company had common stock of $400,000 and retained earnings of $140,000 An examination of Shaw Company’s assets and liabilities revealed that their book value was equal to their fair value except for marketable securities and equipment: Marketable securities Equipment Slide 5-8 Book Value $ 20,000 120,000 Fair Value $ 45,000 140,000 Diff erence $ 25,000 20,000 LO Allocation of difference in a partially owned subsidiary Allocation Allocation of of Difference Difference E5-1: A Prepare a Computation and Allocation Schedule for the difference between book value of equity acquired and the value implied by the purchase price Purchase price and implied value Book value of equity acquired: Common stock Retained earings Total book value Difference between implied and book value Marketable securities Equipment Balance Record new goodwill Balance Slide 5-9 85% Parent Share $ 540,000 340,000 119,000 459,000 81,000 (21,250) (17,000) 42,750 (42,750) $ 15% NCI Share $ 95,294 $ 60,000 21,000 81,000 14,294 (3,750) (3,000) 7,544 (7,544) 100% Total Value $ 635,294 400,000 140,000 540,000 95,294 (25,000) (20,000) 50,294 (50,294) $ LO CAD Schedule for less than wholly owned subsidiary Allocation Allocation of of Difference Difference E5-1 (variation): Prepare the worksheet entries to eliminate the investment, recognize the noncontrolling interest, and to allocate the difference between implied and book Common stock 400,000 Retained earnings 140,000 Difference between Implied and Book 95,294 Investment in Shaw Noncontrolling interest in Equity Marketable securities 25,000 Equipment 20,000 Goodwill 50,294 Difference between Implied and Book Slide 5-10 540,000 95,294 95,294 LO Allocation of difference in a partially owned subsidiary Additional Additional Considerations Considerations Relating Relating to to Treatment Treatment of of Difference Difference Between Between Implied Implied and and Book Book Values Values Allocation of Difference between Implied and Book Values to Long-Term Debt  To measure fair value, use valuation techniques that are consistent with the market approach or income approach  Quoted market prices are the best If unavailable, then management’s best estimate based on  debt with similar characteristics or  valuation techniques such as present value Slide 5-32 LO Allocating difference to long-term debt Additional Additional Considerations Considerations Relating Relating to to Treatment Treatment of of Difference Difference Between Between Implied Implied and and Book Book Values Values Allocating the Difference to Assets (Liabilities) with Fair Values Less (Greater) Than On theBook date ofValues acquisition, sometimes the  fair value of an asset is less than the amount recorded on the books of the subsidiary  fair value of long-term debt may be greater rather than less than its recorded value on the books of the subsidiary Slide 5-33 LO Allocating when the fair value is below book value Additional Additional Considerations Considerations Relating Relating to to Treatment Treatment of of Difference Difference Between Between Implied Implied and and Book Book Values Values Allocating the Difference to Assets (Liabilities) with Fair Values Less (Greater) Than Book Values E5-1 (Variation): On January 1, 2010, Pam Company purchased an 85% interest in Shaw Company for $540,000 On this date, Shaw Company had common stock of $400,000 and retained earnings of $140,000 An examination of Shaw Company’s assets and liabilities revealed that their book value was equal to their fair value except for marketable securities and equipment: Marketable securities Equipment (5 year lif e) Slide 5-34 Book Value $ 20,000 120,000 Fair Value $ 45,000 100,000 Diff erence $ 25,000 (20,000) LO Allocating when the fair value is below book value Cost Method Allocation Allocation of of Difference Difference E5-1: A Prepare a Computation and Allocation Schedule for the difference between book value of equity acquired and the value implied by the purchase price Purchase price and implied value Book value of equity acquired: Common stock Retained earings Total book value Difference between implied and book value Marketable securities Equipment Balance Record new goodwill Balance Slide 5-35 85% Parent Share $ 540,000 340,000 119,000 459,000 81,000 (21,250) 17,000 76,750 (76,750) $ - 15% NCI Share $ 95,294 $ 60,000 21,000 81,000 14,294 (3,750) 3,000 13,544 (13,544) - 100% Total Value $ 635,294 400,000 140,000 540,000 95,294 (25,000) 20,000 90,294 (90,294) $ - LO Allocating when the fair value is below book value Cost Method Allocation Allocation of of Difference Difference E5-1 (variation): At the end of the first year, the workpaper entries are: Marketable securities 25,000 Goodwill 90,294 Difference between Implied and Book Equipment Equipment,net 95,294 20,000 4,000 Depreciation expense ($20,000 / years) 4,000 Note: the overvaluation of equipment will be amortized over the life of the asset as a reduction of depreciation expense Slide 5-36 LO Allocating when the fair value is below book value Cost Method Allocation Allocation of of Difference Difference E5-1 (variation): At the end of the second year, the workpaper entries are: Marketable securities 25,000 Goodwill 90,294 Difference between Implied and Book Equipment Equipment, net 95,294 20,000 8,000 Beg retained earnings - Pam Noncontrolling interest in equity Depreciation expense ($20,000 / years) Slide 5-37 3,400 600 4,000 LO Allocating when the fair value is below book value Allocation Allocation of of Difference Difference Reporting Accumulated Depreciation in Consolidated Financial Statements as a Separate Balance E5-7: On January 1, 2011, Packard Company purchased an 80% interest in Sage Company for $600,000 On this date Sage Company had common stock of $150,000 and retained earnings of $400,000 Sage Company’s equipment on the date of Packard Company’s purchase had a book value of $400,000 and a fair value of $600,000 All equipment had an estimated useful life of 10 years on January 2, 2006 Required: Prepare the December 31 consolidated financial statements workpaper entries for 2011 and 2012, recording accumulated depreciation as a separate balance Slide 5-38 LO Depreciable assets at net and gross values Allocation Allocation of of Difference Difference E5-7: Prepare a Computation and Allocation Schedule Purchase price and implied value Book value of equity acquired: Common stock Retained earings Total book value Difference between implied and book value Equipment Balance Slide 5-39 80% Parent Share $ 600,000 120,000 320,000 440,000 160,000 (160,000) $ - 20% NCI Share $ 150,000 $ 30,000 80,000 110,000 40,000 (40,000) - 100% Total Value $ 750,000 150,000 400,000 550,000 200,000 (200,000) $ - LO Depreciable assets at net and gross values Cost & Partial Allocation Allocation of of Difference Difference Equity Method E5-7: Prepare the December 31 consolidated financial statements workpaper entries for 2011 and 2012 Equipment 400,000 Accumulated depreciation 200,000 Difference between Implied and Book 200,000 Depreciation Expense ($200,000/5) Accumulated Depreciation Slide 5-40 40,000 40,000 LO Depreciable assets at net and gross values Cost & Partial Allocation Allocation of of Difference Difference Equity Method E5-7: Prepare the December 31 consolidated financial statements workpaper entries for 2011 and 2012 Equipment 400,000 Accumulated depreciation 200,000 Difference between Implied and Book 200,000 1/1 Retained Earnings -Packard Co 1/1 Noncontrolling interest Depreciation Expense ($200,000/5) Accumulated Depreciation 32,000 8,000 40,000 80,000 * Complete equity method: debit to 1/1 Retained Earnings – Packard Co would be replaced with a debit to Investment in Sage Company Slide 5-41 LO Depreciable assets at net and gross values Allocation Allocation of of Difference Difference Disposal of Depreciable Assets by Subsidiary In the year of sale, any gain or loss recognized by the subsidiary on the disposal of an asset to which any of the difference between implied and book value has been allocated must be adjusted in the consolidated statements workpaper Depreciable Assets Used in Manufacturing When the difference between implied and book values is allocated to depreciable assets used in manufacturing, workpaper entries may be more complex because the current and previous years additional depreciation may need to be allocated among work in process, finished goods, and cost of goods sold Slide 5-42 LO Depreciable assets at net and gross values Push Push Down Down Accounting Accounting Push down accounting is the establishment of a new accounting and reporting basis for a subsidiary company in its separate financial statements based on the purchase price paid by the parent to acquire the controlling interest The valuation implied by the price of the stock to the parent company is “pushed down” to the subsidiary and used to restate its assets (including goodwill) and liabilities in its separate financial statements Slide 5-43 LO 10 Push down of accounting to the subsidiary’s books Push Push Down Down Accounting Accounting Arguments for and against Push Down Accounting Three important factors that should be considered in determining the appropriateness of push down accounting are: Whether the subsidiary has outstanding debt held by the public Whether the subsidiary has outstanding a senior class of capital stock not acquired by the parent company The level at which a major change in ownership of an entity should be deemed to have occurred, for example, 100%, 90%, 51% Slide 5-44 LO 10 Push down of accounting to the subsidiary’s books Push Push Down Down Accounting Accounting Status of Push Down Accounting As a general rule, the SEC requires push down accounting when the ownership change is greater than 95% and objects to push down accounting when the ownership change is less than 80% In addition, the SEC staff expresses the view that the existence of outstanding public debt, preferred stock, or a significant noncontrolling interest in a subsidiary might impact the parent company’s ability to control the form of ownership In these circumstances, push down accounting, though not required, is an acceptable accounting method Slide 5-45 LO 10 Push down of accounting to the subsidiary’s books Copyright Copyright Copyright © 2012 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Slide 5-46