PPT5-Allocation and Depreciation of Differences Between Implied and Book Values

ACCT6381
Advanced Accounting
Week 5
Allocation and Depreciation of Differences
Between Implied and Book Values
Allocation and Depreciation of Differences
Between Implied and Book Values
2
Learning Objectives
• Calculate the difference between implied and book values and
allocate to the subsidiary’s assets and liabilities.
• Describe FASB’s position on accounting for bargain acquisitions.
• Explain how goodwill is measured at the time of the acquisition.
• Describe how the allocation process differs if less than 100% of the
subsidiary is acquired.
• Record the entries needed on the parent’s books to account for the
investment under the three methods: the cost, the partial equity, and
the complete equity methods.
3
Learning Objectives (continued)
• Prepare workpapers for the year of acquisition and the year(s) subsequent to
the acquisition, assuming that the parent accounts for the investment
alternatively using the cost, the partial equity, and the complete equity
methods.
• Understand the allocation of the difference between implied and book values
to long-term debt components.
• Explain how to allocate the difference between implied and book values when
some assets have fair values below book values.
• Distinguish between recording the subsidiary depreciable assets at net versus
gross fair values.
• Understand the concept of push down accounting.
4
Allocation of Difference Between Implied and
Book Values: Acquisition Date
• When consolidated financial statements are prepared, asset and
liability values must be adjusted by allocating the difference between
implied and book values to specific recorded or unrecorded tangible
and intangible assets and liabilities.
• In the case of a wholly owned subsidiary, the implied value of the
subsidiary equals the acquisition price.
LO 1 Computation and Allocation of Difference (CAD). 5

• Allocation of difference between implied and book values at date of
acquisition - wholly owned subsidiary (implied value equals
acquisition price).
• Step 1: Difference used first to adjust the individual assets and
liabilities to their fair values on the date of acquisition.
• Step 2: Any residual amount:
• Implied value > aggregate fair values = goodwill.
• Implied value < aggregate fair values = bargain. Bargain is recognized as an
ordinary gain.
LO 1 Computation and Allocation of Difference (CAD). 6

Bargain Rules under prior GAAP (before 2007 standard):
• Acquired assets, except investments accounted for by the equity method, are
recorded at fair market value.
• Previously recorded goodwill is eliminated.
• Long-lived assets (including in-process R&D and excluding long-term
investments) are recorded at fair market value minus an adjustment for the
bargain.
• Extraordinary gain recorded if all long-lived assets are reduced to zero.
• Current GAAP eliminates these rules and requires an ordinary gain to be recognized
instead.
LO 2 Current and past treatment of bargain acquisitions. 7

• Bargain Rules: When a bargain acquisition occurs, under FASB ASC
paragraph 805-30-25-2, the negative (or credit) balance should be
recognized as an ordinary gain in the year of acquisition. No assets
should be recorded below their fair values.
• Note: A true bargain is not likely to occur except in situations where
nonquantitative factors play a role.
• For example, a closely held company wishes to sell quickly because of the health of a
family member.
LO 2 Current and past treatment of bargain acquisitions. 8

Review Question
In the event of a bargain acquisition (after carefully considering the fair
valuation of all subsidiary assets and liabilities) the FASB requires the
following accounting:
a) an ordinary gain is reported in the financial statements of the consolidated
entity.
b) an ordinary loss is reported in the financial statements of the consolidated
entity.
c) negative goodwill is reported on the balance sheet.
d) assets are written down to zero value, if needed.
LO 2 Current and past treatment of bargain acquisitions.

9
Allocation of Difference
Case 1: Implied Value “in Excess of” Fair Value
E5-1: On January 1, 2013, Pam Company purchased an 85% interest in Shaw
Company for $540,000. On this date, Shaw Company had common stock of
$400,000 and retained earnings of $140,000. An examination of Shaw
Company’s assets and liabilities revealed that their book value was equal to
their fair value except for marketable securities and equipment:
LO 1 Computation and Allocation of Difference (CAD).

LO 4 Allocation of difference in a partially owned subsidiary.
10
E5-1: A. Prepare a Computation and Allocation Schedule for the difference
between book value of equity acquired and the value implied by the purchase
price.
LO 4 CAD Schedule for less than wholly owned subsidiary. 11

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 Value 95,294
Investment in Shaw 540,000
Noncontrolling Interest in Equity 95,294
Marketable Securities 25,000

Equipment 20,000
Goodwill 50,294
LO 4 Allocation of difference in a partially owned subsidiary. 12
Case 2: Acquisition Cost “Less Than” Fair Value
E5-1 (variation): On January 1, 2013, Pam Company purchased an 85%
interest in Shaw Company for $470,000. On this date, Shaw Company had
common stock of $400,000 and retained earnings of $140,000. An examination
of Shaw Company’s assets and liabilities revealed that their book value was
equal to their fair value except for marketable securities and equipment:

E5-1 (variation): Prepare a
Computation and Allocation Schedule.
LO 4 CAD Schedule for less than wholly owned subsidiary. 14

E5-1 (variation): Prepare the worksheet entries.
Common Stock 400,000
Retained Earnings 140,000
Investment in Shaw 470,000

Equipment 20,000
Gain on Acquisition 27,250

Effect of Differences Between Implied and Book Values
on Consolidated Net Income: Year Subsequent To
Acquisition
• When any portion of the difference between implied and book values
is allocated to depreciable and amortizable assets, recorded income
must be adjusted in determining consolidated net income in current
and future periods.
• Adjustment is needed to reflect the difference between the amount
of amortization and/or depreciation recorded by the subsidiary and
the appropriate amount based on consolidated carrying values.

Consolidated Statements – Cost Method
P5-4: On January 1, 2013, Porter Company purchased an 80% interest in
Salem Company for $850,000. At that time, Salem Company had capital stock
of $550,000 and retained earnings of $80,000. Differences between the fair
value and the book value of the identifiable assets of Salem Company were as
follows:
The book values of all other assets and liabilities of Salem Company were
equal to their fair values on January 1, 2013. The equipment had a remaining
life of five years (on January 1, 2013). The inventory was sold in 2013.
Year of LO6 Workpaper entries (cost method).
Acquisition 17
P5-4: Salem Company’s net income and dividends declared in 2013 and 2014
were as follows: 2013 Net Income of $100,000; Dividends Declared of $25,000;
2014 Net Income of $110,000; Dividends Declared of $35,000.
Entries recorded on the books of Porter to reflect the acquisition of Salem and
the receipt of dividends for 2013 are as follows:
Investment in Salem 850,000

Cash 850,000
Cash 20,000
Dividend Income ($25,000 x 80%) 20,000
Year of
Acquisition LO 5 Recording investment on books of Parent. 18
P5-4: A. Prepare a Computation and Allocation Schedule
Year of
Acquisition LO 4 CAD Schedule for less than wholly owned subsidiary. 19
P5-4: B. 1. Prepare the worksheet entries for Dec. 31, 2013.
Dividends Declared 20,000
Beg. Retained Earnings - Salem 80,000

Common Stock - Salem 550,000
Difference between Cost and Book Value 432,500
Year of
Acquisition LO 6 Workpaper entries (cost method). 20
P5-4: B. 1. Prepare the worksheet entries for Dec. 31, 2013.
Cost of Goods Sold 40,000
Land 65,000
Plant and Equipment 130,000
Goodwill 197,500
Depreciation Expense ($130,000/5) 26,000

Year of
Acquisition LO 6 Workpaper entries (cost method). 21
P5-4: C. 1. Prepare the worksheet entries for Dec. 31, 2014.
Salem 2014 income $100,000
Salem 2014 dividends declared - 25,000
Total 75,000
Ownership percentage 80%
$ 60,000

Beg. Retained Earnings ‑ Porter Co. 60,000
To establish reciprocity/convert to equity as of 1/1/2014
Subsequent
Year LO 6 Workpaper entries (cost method). 22

Subsequent
1/1 Retained Earnings – Porter 32,000
Noncontrolling interest 8,000
Land 65,000
Goodwill 197,500

Noncontrolling Interest 5,200
Subsequent
• P5-4: D. Prepare a consolidated financial statements workpaper for

the year ended December 31, 2015. Although no goodwill impairment
was reflected at the end of 2013 or 2014, the goodwill impairment
test conducted at December 31, 2015 revealed implied goodwill from
Salem to be only $150,000. The impairment has not been recorded in
the books of the parent. (Hint: You can infer the method being used
by the parent from the information in its trial balance.)

LO 6 Workpaper entries (cost method).
Subsequent
Year 25
P5-4: D. 2015 Year Subsequent of Acquisition
Subsequent LO 6 Workpaper entries (cost method). 26

Year
P5-4: D. 2015 Year Subsequent of Acquisition
Subsequent
P5-4: D. Explanations of worksheet entries for Dec. 31, 2015.
Acquisition date retained earnings - Salem $ 80,000
Retained earnings 1/1/15 - Salem 230,000
Increase 150,000
Ownership percentage 80%
$ 120,000

Beg. Retained Earnings ‑ Porter Co. 120,000
To establish reciprocity/convert to equity as of 1/1/2015
Subsequent
P5-4 D. Worksheet entries for Dec. 31, 2015.

Subsequent
Noncontrolling Interest 8,000
Land 65,000
Goodwill 197,500
Subsequent
1/1 Retained Earnings – Porter (2 years) 41,600
Noncontrolling Interest (2 years) 10,400
Impairment Loss ($197,500 - $150,000) 47,500

Goodwill 47,500
To record goodwill impairment
Subsequent
Consolidated Statements – Partial and Complete
Equity Methods
• The equity methods (partial and complete) reflect the effects of
certain transactions more fully than the cost method on the books of
the parent.
• However consolidated totals are the same regardless of which
method is used by the Parent company.
LO 5 Recording investment by Parent, partial equity method.

LO 5 Recording investment by Parent, complete equity method. 32
Additional Considerations Relating to Treatment of
Difference Between Implied and Book Values
Allocation of Difference between Implied and Book Values to Long-

Term Debt
Notes payable, long-term debt, and other obligations of an acquired
company should be valued for consolidation purposes at their fair
values.
• Fair value is the price that would be paid to transfer a liability in an orderly
transaction between market participants at the measurement date. A fair
value measurement assumes:
• The liability is transferred to a market participant at the measurement date and
• The nonperformance risk relating to the liability is the same before and after its transfer.
LO 7 Allocating difference to long-term debt. 33

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 prices in active markets for identical liabilities are the best. If
unavailable, then management’s best estimate based on
• debt with comparable characteristics or
• valuation techniques such as present value.
LO 7 Allocating difference to long-term debt. 34

Allocating the Difference to Assets (Liabilities) with Fair Values Less

(Greater) Than Book Values
• On the date of acquisition, sometimes the
• fair value of an asset is less than the amount recorded on the books of the
subsidiary.
• fair value of long-term debt may be greater rather than less than its recorded
value on the books of the subsidiary.
LO 8 Allocating when the fair value is below book value. 35

Allocating the Difference to Assets (Liabilities) with Fair
Values Less (Greater) Than Book Values
E5-1 (Variation): On January 1, 2013, Pam Company purchased an 85%
interest in Shaw Company for $540,000. On this date, Shaw Company had
common stock of $400,000 and retained earnings of $140,000. An examination
of Shaw Company’s assets and liabilities revealed that their book value was
equal to their fair value except for marketable securities and equipment:

Cost
Method
E5-1: A. Prepare a Computation and Allocation Schedule for the
difference between book value of equity acquired and the value implied by
the purchase price.

Cost
Method
E5-1 (variation): At the end of the first year, the workpaper entries are:

Goodwill 90,294
Equipment 20,000
Equipment, net 4,000

Depreciation Expense ($20,000 / 5 years) 4,000
Note: The overvaluation of equipment will be amortized over the life

of the asset as a reduction of depreciation expense.

Cost
Method
E5-1 (variation): At the end of the second year, the workpaper entries are:

Goodwill 90,294
Equipment 20,000
Equipment, net 8,000

Beg. Retained Earnings - Pam 3,400
Noncontrolling Interest in Equity 600
Depreciation Expense ($20,000 / 5 years) 4,000

Reporting Accumulated Depreciation in Consolidated Financial Statements as a
Separate Balance
• E5-7: On January 1, 2014, Packard Company purchased an 80% interest in Sage
Company for $600,000. On this date Sage Company had common stock of
$150,000 and retained earnings of $400,000. Sage Company’s equipment on the
date of Packard Company’s purchase had a book value of $400,000 and a fair value
of $600,000. All equipment had an estimated useful life of 10 years on January 2,
2009.
Required: Prepare the December 31 consolidated financial statements workpaper

entries for 2014 and 2015, recording accumulated depreciation as a separate
balance.
LO 9 Depreciable assets at net and gross values. 40
E5-7: Prepare a Computation and Allocation Schedule.

E5-7: Prepare the December 31 consolidated financial statements
workpaper entries for 2014 and 2015.
Equipment 400,000*
Accumulated Depreciation 200,000**
Cost & Partial

Equity Method


Accumulated Depreciation 40,000
Cost & Partial

Equity Method

Equipment 400,000
1/1 Retained Earnings -Packard Co. 32,000

Cost & Partial
1/1 Noncontrolling Interest 8,000 Equity Method
* Complete equity method: debit to 1/1 Retained Earnings – Packard Co. would be
replaced with a debit to Investment in Sage Company

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.
Push Down Accounting
• Push down accounting is the establishment of a new accounting and
reporting basis for a subsidiary company in its separate financial
statements based on the purchase price paid by the parent to acquire
the controlling interest.
• The valuation implied by the price of the stock to the parent company
is “pushed down” to the subsidiary and used to restate its assets
(including goodwill) and liabilities in its separate financial statements.
LO 10 Push down of accounting to the subsidiary’s books. 46

•Push down accounting is based on the notion that the basis of
accounting for purchased assets and liabilities should be the same
regardless of whether the acquired company continues as a separate
subsidiary or is merged into the parent company’s operations.
•The parent’s cost of acquiring a subsidiary is used to establish a new accounting

basis for the assets and liabilities of the subsidiary in the subsidiary’s separate
financial statements.
•Because push down accounting has not been addressed in authoritative

pronouncements of the FASB or its predecessors, practice has been inconsistent.
Arguments For and Against Push Down Accounting
• Three important factors that should be considered in determining the
appropriateness of push down accounting are:
1) Whether the subsidiary has outstanding debt held by the public.
2) Whether the subsidiary has outstanding a senior class of capital stock not
acquired by the parent company.
3) The level at which a major change in ownership of an entity should be
deemed to have occurred, for example, 100%, 90%, 51%.

Status of Push Down Accounting
On January 17, 2013, FASB’s Emerging Issues Task Force
• Decided:
To consider at a future meeting whether push down accounting should be
mandatory.
That push down accounting would be required for public business entities
under specified circumstances.
•Tentatively Decided:
To allow public business entities and non-public entities to have an option to
apply push down accounting upon occurrence of a change-in-control event.
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.
51

PPT5-Allocation and Depreciation of Differences Between Implied and Book Values

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ACCT6381

LO 1 Computation and Allocation of Difference (CAD). 5

LO 1 Computation and Allocation of Difference (CAD). 6

LO 2 Current and past treatment of bargain acquisitions. 7

LO 2 Current and past treatment of bargain acquisitions. 8

LO 2 Current and past treatment of bargain acquisitions.

LO 1 Computation and Allocation of Difference (CAD).

LO 4 CAD Schedule for less than wholly owned subsidiary. 11

Marketable Securities 25,000

LO 4 Allocation of difference in a partially owned subsidiary. 13

LO 4 CAD Schedule for less than wholly owned subsidiary. 14

Marketable Securities 25,000

LO 4 Allocation of difference in a partially owned subsidiary. 15

LO 4 Allocation of difference in a partially owned subsidiary. 16

Investment in Salem 850,000

Beg. Retained Earnings - Salem 80,000

Depreciation Expense ($130,000/5) 26,000

Investment in Salem 60,000

Beg. Retained Earnings - Salem 155,000

1/1 Retained Earnings – Porter 20,800

• P5-4: D. Prepare a consolidated financial statements workpaper for

LO 4 Allocation of difference in a partially owned subsidiary.

Subsequent LO 6 Workpaper entries (cost method). 26

Investment in Salem 120,000

Beg. Retained Earnings - Salem 230,000

Impairment Loss ($197,500 - $150,000) 47,500

LO 5 Recording investment by Parent, partial equity method.

Allocation of Difference between Implied and Book Values to Long-

LO 7 Allocating difference to long-term debt. 33

Allocation of Difference between Implied and Book Values to Long-

LO 7 Allocating difference to long-term debt. 34

Allocating the Difference to Assets (Liabilities) with Fair Values Less

LO 8 Allocating when the fair value is below book value. 35

LO 8 Allocating when the fair value is below book value. 36

LO 8 Allocating when the fair value is below book value. 37

Marketable Securities 25,000

Equipment, net 4,000

Note: The overvaluation of equipment will be amortized over the life

LO 8 Allocating when the fair value is below book value. 38

Marketable Securities 25,000

Equipment, net 8,000

LO 8 Allocating when the fair value is below book value. 39

Required: Prepare the December 31 consolidated financial statements workpaper

LO 9 Depreciable assets at net and gross values. 41

Cost & Partial

LO 9 Depreciable assets at net and gross values. 42

Depreciation Expense ($200,000/5) 40,000

Cost & Partial

LO 9 Depreciable assets at net and gross values. 43

1/1 Retained Earnings -Packard Co. 32,000

LO 9 Depreciable assets at net and gross values. 44

LO 10 Push down of accounting to the subsidiary’s books. 46

•The parent’s cost of acquiring a subsidiary is used to establish a new accounting

•Because push down accounting has not been addressed in authoritative

LO 10 Push down of accounting to the subsidiary’s books. 48

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