Advanced Accounting by Debra Jeter and Paul Chaney

1. Advanced Accountingby Debra Jeter and Paul Chaney Chapter 5: Allocation and Depreciation of Difference between Cost and Book Values Slides Authored by Hannah Wong, Ph.D. Rutgers University

2. Allocation of Purchase Differential I n c l u d e s Book value of net assets acquired Acquisition cost A l l o c a t e t o (MV-BV) of identifiable net assets Goodwill (if amount >0) or bargain purchase (if amount <0) Purchase differential obj 1

3. Bargain Purchase Valuation of Net Assets Acquired: • Current assets, long-term investments in marketable securities, liabilities = fair value • Previously recorded goodwill = eliminated • Long-term assets = fair value - bargain allocation (The bargain is allocated to long-term assets in proportion to their fairvalue.) • Any remaining bargain is recorded as an extraordinary gain in the year of acquisition. obj 2

4. Case 1: Positive Goodwill Wholly Owned Subsidiary I n c l u d e s Book value of net assets acquired $2,000,000 Acquisition cost $2,750,000 A l l o c a t e t o Inventory $50,000 Equipment $300,000 Purchase differential $750,000 Land $150,000 Goodwill $250,000 obj 3

5. Case 1: Positive Goodwill 80% Owned Subsidiary Book value of net assets acquired $1,600,000 I n c l u d e s Note: identifiable net assets are written up only by : P% x (MV-BV) Acquisition cost $2,200,000 A l l c a t e t o Inventory $40,000 Equipment $240,000 Purchase differential $600,000 Land $120,000 Goodwill $200,000 obj 4

6. Entries for Cost, Partial Equity & Full Equity Methods Assume • P pays $2,200,00 for investment in S. • S pays $16,000 in dividends to P. • S’s portion of P’s net income is $100,000. • Acquisition price includes a premium allocated $40,000 to inventory and $240,000 to 10 year depreciable assets. • Make entries for year of acquisition obj 5

7. The Entries * $40,00 inventory premium flow through COGS and $240,000/10 yrs of depreciation. obj 5

8. Allocation of Difference between Cost & Book Value to Long-Term Debt • Long term debt should be valued at fair value on date of acquisition. Fair Value • Prevailing market prices • Fair value of debt with similar characteristics • Present value of future cash flows obj 7

9. The Allocation EE Complete Equity Method End of Year of Acquisition Cost of goods sold 40,000 Depreciation expense 24,000 Equipment 216,000 Land 120,000 Goodwill 200,000 Difference between cost and book value 600,000 Add up to $64,000, becomes the 1/1 R/E adjustment in the next year obj 8

10. Reporting Acquired Assets at “Net” versus “Gross” Fair Value • Net fair value – fair value of the used asset at date of acquisition. (AKA “Sound value”) • Gross fair value – replacement cost new for the asset at date of acquisition of subsidiary. • If you record assets at gross you must establish sufficient accumulated depreciation to bring book value down to net. Adds another item to the worksheet. obj 9

11. Push Down Accounting • Definition • A subsidiary changes the accounting basis in its separate financial statements based on the purchase price paid by the parent for its stock. obj 10

12. Push Down Accounting Push down accounting should not be used Yes S has outstanding public debt? No Yes S has outstanding senior class of capital stock? Push down accounting is recommended No <80% What is P’s % of ownership? 80-95% Push down accounting is required >95% obj 10

13. Advanced Accountingby Debra Jeter and Paul Chan Copyright © 2001 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. obj 2

14. Eliminated slides follow:

15. Case 1: Positive Goodwill Wholly Owned Subsidiary Book value of net assets acquired $2,000,000 Acquisition cost $2,750,000 Inventory $50,000 Equipment $300,000 Purchase differential $750,000 Land $150,000 Goodwill $250,000 obj 2

16. Case 1: Positive Goodwill - EE’s The Investment Entry Retained earnings - S 400,000 Capital stock - S 1,200,000 Difference between cost and book value 600,000 Investment in S 2,200,000 The Allocation Entry Inventory 40,000 Equipment 240,000 Land 120,000 Goodwill 200,000 Difference between cost and book value 600,000 obj 2

17. Case 2A: Bargain PurchaseBV < Cost 80% Owned Subsidiary Book value of net assets acquired $1,600,000 Note: identifiable net assets are written up only by : P% x (MV-BV) Acquisition cost $1,900,000 Inventory $40,000 Equipment $240,000 Purchase differential $300,000 Land $120,000 Bargain purchase $100,000 obj 2

18. Case 2A: Bargain PurchaseBV < Cost Allocation of Bargain Purchase Note: assets are reduced in proportion to their fair values, not book values Reduction in asset amounts: Equipment $30,000 Land $20,000 Bargain purchase $100,000 Other noncurrent assets $50,000 obj 2

19. Case 2A: Bargain PurchaseBV < Cost : EE’s Retained earnings - S 400,000 Capital stock - S 1,200,000 Difference between cost and book value 300,000 Investment in S 1,900,000 The Investment Entry The Allocation Entry Inventory 40,000 Equipment (240,000-30,000) 210,000 Land (120,000-20,000) 100,000 Other noncurrent assets (0-50,000) 50,000 Difference between cost and book value 300,000 obj 2

20. Case 2B: Bargain PurchaseBV > Cost 80% Owned Subsidiary Book value of net assets acquired $1,600,000 Note: identifiable net assets are written up only by : P% x (MV-BV) Acquisition cost $1,500,000 Inventory $40,000 Equipment $240,000 Purchase differential -$100,000 Land $120,000 Bargain purchase $500,000 obj 2

21. Case 2B: Bargain PurchaseBV > Cost Allocation of Bargain Purchase Note: assets are reduced in proportion to their fair values, not book values Reduction in asset amounts: Equipment $150,000 Bargain purchase $500,000 Land $100,000 Other noncurrent assets $250,000 obj 2

22. Case 2B: Bargain PurchaseBV > Cost : EE’s The Investment Entry Retained earnings - S 400,000 Capital stock - S 1,200,000 Difference between cost and book value 100,000 Investment in S 1,500,000 The Allocation Entry Difference between cost and book value 100,000 Inventory 40,000 Equipment (240,000-150,000) 90,000 Land (120,000-100,000) 20,000 Other noncurrent assets (0-250,000) 250,000 obj 2

23. Amortization of Purchase Differential Case 1: Positive Goodwill, 80% Owned Subsidiary Purchase differential Annual adjustments to consolidated NI 2001 2002-2010 2011-2020 Inventory $40,000 Inventory $40,000 Inventory $40,000 Inventory $40,000 Inventory $40,000 COGS $40,000 Inventory $40,000 Inventory $40,000 Depreciation expense $24,000 Depreciation expense $24,000 Equipment $240,000 Land $120,000 Goodwill $200,000 obj 2

24. Amortization of Purchase Differential Case 1: Positive Goodwill, 80% Owned Subsidiary Annual adjustments to beginning consolidated R/E 2001 2001 2002 COGS $40,000 Depreciation expense $24,000 Depreciation expense $24,000 Consolidated NI adjustments Depreciation expense $24,000 Adjustments to 1/1 R/E = sum of NI adjustments in all previous years 0 64,000 88,000 obj 2

25. The Allocation EE Cost Method End of Year of Acquisition Cost of goods sold 40,000 Depreciation expense 24,000 Equipment 216,000 Land 120,000 Goodwill 200,000 Difference between cost and book value 600,000 Add up to $64,000, becomes the 1/1 R/E adjustment in the next year obj 2

26. The Allocation EE Cost Method Year Subsequent to Acquisition Beginning retained earnings 64,000 Depreciation expense 24,000 Equipment 192,000 Land 120,000 Goodwill 200,000 Difference between cost and book value 600,000 Add up to $88,000, becomes the 1/1 R/E adjustment in the next year obj 2

27. The Allocation EE Cost Method 2 Years Subsequent to Acquisition Beginning retained earnings 88,000 Depreciation expense 24,000 Equipment 168,000 Land 120,000 Goodwill 200,000 Difference between cost and book value 600,000 obj 2

28. The Allocation EE Partial Equity Method End of Year of Acquisition Cost of goods sold 40,000 Depreciation expense 24,000 Equipment 216,000 Land 120,000 Goodwill 190,000 Difference between cost and book value 600,000 Add up to $64,000, becomes the 1/1 R/E adjustment in the next year (see next slide) obj 2

29. The Allocation EE Partial Equity Method Year Subsequent to Acquisition Beginning retained earnings 64,000 Depreciation expense 24,000 Equipment 192,000 Land 120,000 Goodwill 200,000 Difference between cost and book value 600,000 Add up to $88,000, becomes the 1/1 R/E adjustment in the next year (see next slide) obj 2

30. The Allocation EE Complete Equity Method Year Subsequent to Acquisition Investment in S 64,000 Depreciation expense 24,000 Equipment 192,000 Land 120,000 Goodwill 200,000 Difference between cost and book value 600,000 Add up to $88,000, becomes the 1/1 R/E adjustment in the next year (see next slide) Note: The investment account, instead of the beginning R/E, is adjusted under the complete equity method obj 2