ch05.ppt

1
Allocation and Depreciation of
Differences Between Implied and
Book Values Acquisition
Advanced Accounting, Fifth Edition
5

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1. Calculate the difference between implied and book values and allocate to the
subsidiary’s assets and liabilities.
2. Describe FASB’s position on accounting for bargain acquisitions.
3. Explain how goodwill is measured at the time of the acquisition.
4. Describe how the allocation process differs if less than 100% of the subsidiary is
acquired.
5. 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.
6. 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.
7. Understand the allocation of the difference between implied and book values to long-
term debt components.
8. Explain how to allocate the difference between implied and book values when some
assets have fair values below book values.
9. Distinguish between recording the subsidiary depreciable assets at net versus gross
fair values.
10. Understand the concept of push down accounting.
Learning Objectives

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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.
Allocation of Difference Between Implied
and Book Values: Acquisition Date
LO 1 Computation and Allocation of Difference.

4
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.
LO 1 Computation and Allocation of Difference.

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Bargain Rules under prior GAAP (before 2007 standard):
1. Acquired assets, except investments accounted for by the equity
method, are recorded at fair market value.
2. Previously recorded goodwill is eliminated.
3. 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.
4. 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 FASB’s position on accounting for bargain acquisitions.

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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.

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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.
Review Question
.

8
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:
Book Value Fair Value Difference
Marketable securities 20,000
$ 45,000
$ 25,000
$
Equipment 120,000 140,000 20,000
Allocation of Difference
Case 1: Implied Value “in Excess of” Fair Value
LO 4 Allocation of difference in a partially owned subsidiary.

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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.
85% 15% 100%
Parent NCI Total
Share Share Value
Purchase price and implied value 540,000
$ 95,294
$ 635,294
$
Book value of equity acquired:
Common stock 340,000 60,000 400,000
Retained earings 119,000 21,000 140,000
Total book value 459,000 81,000 540,000
Difference between implied and book value 81,000 14,294 95,294
Marketable securities (21,250) (3,750) (25,000)
Equipment (17,000) (3,000) (20,000)
Balance 42,750 7,544 50,294
Record new goodwill (42,750) (7,544) (50,294)
Balance 0
$ 0
$ 0
$
LO 4 CAD Schedule for less than wholly owned subsidiary.

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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 540,000
Noncontrolling interest in Equity 95,294
Equipment 20,000
Goodwill 50,294

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E5-1 (variation): On January 1, 2010, Pam Company purchased an
85% interest in Shaw Company for $470,000. On this date, Shaw
$ 45,000
$ 25,000
$
Equipment 120,000 140,000 20,000
Case 2: Acquisition Cost “Less Than” Fair Value

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85% 15% 100%
Parent NCI Total
Share Share Value
$ 82,941
$ 552,941
$
Common stock 340,000 60,000 400,000
Total book value 459,000 81,000 540,000
Equipment (17,000) (3,000) (20,000)
Balance (excess of FV over implied value) (27,250) (4,809) (32,059)
Pam's gain 27,250
Increase noncontrolling interest to fair
value of assets 4,809
Total allocated gain 32,059
Balance 0 0 0
E5-1 (variation): Prepare a
Computation and Allocation
Schedule.

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E5-1 (variation): Prepare the worksheet entries.
Common stock 400,000
Retained earnings 140,000
Investment in Shaw 470,000
Noncontrolling interest in Equity 82,941
Equipment 20,000
Gain on acquisition 27,250
Noncontrolling interest in equity 4,809

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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.
Effect of Allocation and Depreciation of Differences on
Consolidated Net Income: Year Subsequent To Acquisition

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P5-4: On January 1, 2010, 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:
Fair Value in Excess of Book Value
Equipment 130,000
$
Land 65,000
Inventory 40,000
Consolidated Statements – Cost Method
The book values of all other assets and liabilities of Salem Company
were equal to their fair values on January 1, 2010. The equipment
had a remaining life of five years. The inventory was sold in 2010.
Year of
Acquisition

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P5-4: Salem Company’s net income and dividends declared in 2010
and 2011 were as follows: 2010 Net Income of $100,000; Dividends
Declared of $25,000; 2011 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 2010 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

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P5-4: A. Prepare a Computation and Allocation Schedule
80% 20% 100%
Parent NCI Total
Share Share Value
$ 212,500
$ 1,062,500
$
Common stock 440,000 110,000 550,000
Total book value 504,000 126,000 630,000
Equipment (104,000) (26,000) (130,000)
Land (52,000) (13,000) (65,000)
Inventory (32,000) (8,000) (40,000)
Balance 158,000 39,500 197,500
Balance -
$ -
$ -
$
Year of
Acquisition

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P5-4: B. 1. Prepare the worksheet entries for Dec. 31, 2010.
Dividends declared 20,000
Beg. retained earnings - Salem 80,000
Common stock - Salem 550,000
Difference between Cost and Book 432,500
Year of
Acquisition

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Cost of goods sold 40,000
Land 65,000
Plant and equipment 130,000
Goodwill 197,500
Difference between cost and book 432,500
Depreciation expense ($130,000/5) 26,000
Year of
Acquisition
P5-4: B. 1. Prepare the worksheet entries for Dec. 31, 2010.

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Beg. Retained Earnings - Porter Co. 60,000
Subsequent
Year
Salem 2011 income $100,000
Salem 2011 dividends declared - 25,000
Total 75,000
Ownership percentage 80%
$ 60,000
To establish reciprocity/convert to equity as of 1/1/2011
P5-4: C. 1. Prepare the worksheet entries for Dec. 31, 2011.

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Subsequent
Year

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

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P5-4: D. Prepare a consolidated financial statements
workpaper for the year ended December 31, 2012. Although
no goodwill impairment was reflected at the end of 2010 or
2011, the goodwill impairment test conducted at December 31,
2012 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.)
Subsequent
Year

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Consolidated
Income Statement Porter Salem Debit Credit NCI Balances
Sales 1,100,000
$ 450,000
$ 1,550,000
$
Dividend income 48,000 48,000
Total revenue 1,148,000 450,000 1,550,000
Cost of goods sold 900,000 200,000 1,100,000
Depreciation expense 40,000 30,000 26,000 96,000
Impairment loss 47,500 47,500
Other expenses 60,000 50,000 110,000
Total cost and expense 1,000,000 280,000 1,353,500
Net income 148,000 170,000 196,500
Noncontrolling interest 19,300 (19,300)
Net income 148,000
$ 170,000
$ 121,500
$ 19,300
$ 177,200
$
Retained Earnings Statement
Retained earnings, 1/1/12 500,000 230,000 32,000 120,000 546,400
Porter 41,600
Salem 230,000
Net income 148,000 170,000 121,500 19,300 177,200
Dividends declared (90,000) (60,000) 48,000 (12,000) (90,000)
Retained earnings, 12/31/12 558,000
$ 340,000
$ 425,100
$ 168,000
$ 7,300
$ 633,600
$
Eliminations
P5-4: D. 2012 Year Subsequent of Acquisition
Subsequent
Year

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Consolidated
Income Statement Porter Salem Debit Credit NCI Balances
Cash 70,000
$ 65,000
$ 135,000
$
Accounts receivable 260,000 190,000 450,000
Inventory 240,000 175,000 415,000
Investment in Sid 850,000 120,000 970,000
Difference (IV & BV) 432,500 432,500
Land 320,000 65,000 385,000
Plant and equipment 360,000 280,000 130,000 78,000 692,000
Goodwill 197,500 47,500 150,000
Total assets 1,780,000
$ 1,030,000
$ 2,227,000
$
-
Accounts payable 132,000
$ 110,000
$ 242,000
$
Notes payable 90,000 30,000 120,000
Common stock 1,000,000 550,000 550,000 1,000,000
Retained earnings 558,000 340,000 425,100 168,000 7,300 633,600
1/1 NCI in net assets 8,000 242,500 224,100
10,400
12/31 NCI in net asset 231,400 231,400
Total liab. & equity 1,780,000
$ 1,030,000
$ 1,938,500
$ 1,938,500
$ 2,227,000
$
Eliminations
Subsequent
Year
P5-4: D. 2012 Year Subsequent of Acquisition

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Beg. Retained Earnings - Porter Co. 120,000
Subsequent
Year
Acquisition date retained earnings - Salem $ 80,000
Retained earnings 1/1/12 - Salem 230,000
Increase 150,000
Ownership percentage 80%
$ 120,000
To establish reciprocity/convert to equity as of 1/1/2012
P5-4: D. Explanations of worksheet entries for Dec. 31, 2012.

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Subsequent
Year
P5-4 D. Worksheet entries for Dec. 31, 2012.

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Land 65,000
Goodwill 197,500
Subsequent
Year

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Noncontrolling interest (2 years) 10,400
1/1 Retained Earnings – Porter (2 years) 41,600
Subsequent
Year
Impairment loss ($197,500 - $150,000) 47,500
Goodwill 47,500
To record goodwill impairment

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LO 5 Recording investment by Parent, complete equity method.
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.

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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 and
The nonperformance risk relating to the liability is the same
before and after its transfer.
Additional Considerations Relating to Treatment of
Difference Between Implied and Book Values
Allocation of Difference between Implied and Book
Values to Long-Term Debt
LO 7 Allocating difference to long-term debt.

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 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.
Allocation of Difference between Implied and Book
Values to Long-Term Debt
LO 7 Allocating difference to long-term debt.

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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.
Allocating the Difference to Assets (Liabilities) with
Fair Values Less (Greater) Than Book Values
LO 8 Allocating when the fair value is below book value.

34
E5-1 (Variation): On January 1, 2010, Pam Company purchased an
85% interest in Shaw Company for $540,000. On this date, Shaw
$ 45,000
$ 25,000
$
Equipment (5 year life) 120,000 100,000 (20,000)
Allocating the Difference to Assets (Liabilities) with
Fair Values Less (Greater) Than Book Values

35
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.
85% 15% 100%
Parent NCI Total
Share Share Value
$ 95,294
$ 635,294
$
Common stock 340,000 60,000 400,000
Total book value 459,000 81,000 540,000
Equipment 17,000 3,000 20,000
Balance 76,750 13,544 90,294
Balance -
$ -
$ -
$
Cost
Method

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E5-1 (variation): At the end of the first year, the workpaper
entries are:
Equipment 20,000
Goodwill 90,294
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

37
E5-1 (variation): At the end of the second year, the workpaper
entries are:
Equipment 20,000
Goodwill 90,294
Equipment, net 8,000
Beg. retained earnings - Pam 3,400
Noncontrolling interest in equity 600
Depreciation expense ($20,000 / 5 years) 4,000
Cost
Method

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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.
Reporting Accumulated Depreciation in Consolidated
Financial Statements as a Separate Balance
LO 9 Depreciable assets at net and gross values.

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E5-7: Prepare a Computation and Allocation Schedule.
80% 20% 100%
Parent NCI Total
Share Share Value
$ 150,000
$ 750,000
$
Common stock 120,000 30,000 150,000
Total book value 440,000 110,000 550,000
Equipment (160,000) (40,000) (200,000)
Balance -
$ -
$ -
$

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E5-7: Prepare the December 31 consolidated financial
statements workpaper entries for 2011 and 2012.
Equipment 400,000
Accumulated depreciation 200,000
Depreciation Expense ($200,000/5) 40,000
Accumulated Depreciation 40,000
Cost & Partial
Equity Method

41
E5-7: Prepare the December 31 consolidated financial
statements workpaper entries for 2011 and 2012.
Equipment 400,000
Accumulated depreciation 200,000
1/1 Retained Earnings -Packard Co. 32,000
1/1 Noncontrolling interest 8,000
Depreciation Expense ($200,000/5) 40,000
Accumulated Depreciation 80,000
* Complete equity method: debit to 1/1 Retained Earnings – Packard Co.
would be replaced with a debit to Investment in Sage Company
Cost & Partial
Equity Method

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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.

43
LO 10 Push down of accounting to the subsidiary’s books.
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.

44
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%.

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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.

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Copyright © 2012 John Wiley & Sons, Inc. All rights reserved.
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use of these programs or from the use of the information
contained herein.
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