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Advanced Accounting by 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. Allocation of Purchase Differential. I n c l u d e s. Book value of net assets acquired.

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Advanced accounting by debra jeter and paul chaney l.jpg

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


Allocation of purchase differential l.jpg
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


Bargain purchase l.jpg
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


Case 1 positive goodwill l.jpg
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


Case 1 positive goodwill5 l.jpg
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


Entries for cost partial equity full equity methods l.jpg
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


The entries l.jpg
The Entries

* $40,00 inventory premium flow through COGS and

$240,000/10 yrs of depreciation.

obj 5


Allocation of difference between cost book value to long term debt l.jpg
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


The allocation ee complete equity method l.jpg
The Allocation EE Long-Term DebtComplete 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


Reporting acquired assets at net versus gross fair value l.jpg
Reporting Acquired Assets at Long-Term Debt“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


Push down accounting l.jpg
Push Down Accounting Long-Term Debt

  • 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


Push down accounting12 l.jpg
Push Down Accounting Long-Term Debt

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


Advanced accounting by debra jeter and paul chan l.jpg
Advanced Accounting Long-Term Debtby 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



Case 1 positive goodwill15 l.jpg
Case 1: Positive Goodwill Long-Term Debt

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


Case 1 positive goodwill ee s l.jpg
Case 1: Positive Goodwill - EE’s Long-Term Debt

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


Case 2a bargain purchase bv cost l.jpg
Case 2A: Bargain Purchase Long-Term DebtBV < 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


Case 2a bargain purchase bv cost18 l.jpg
Case 2A: Bargain Purchase Long-Term DebtBV < 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


Case 2a bargain purchase bv cost ee s l.jpg
Case 2A: Bargain Purchase Long-Term DebtBV < 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


Case 2b bargain purchase bv cost l.jpg
Case 2B: Bargain Purchase Long-Term DebtBV > 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


Case 2b bargain purchase bv cost21 l.jpg
Case 2B: Bargain Purchase Long-Term DebtBV > 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


Case 2b bargain purchase bv cost ee s l.jpg
Case 2B: Bargain Purchase Long-Term DebtBV > 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


Amortization of purchase differential l.jpg
Amortization of Purchase Differential Long-Term Debt

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


Amortization of purchase differential24 l.jpg
Amortization of Purchase Differential Long-Term Debt

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


The allocation ee cost method l.jpg
The Allocation EE Long-Term DebtCost 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


The allocation ee cost method26 l.jpg
The Allocation EE Long-Term DebtCost 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


The allocation ee cost method27 l.jpg
The Allocation EE Long-Term DebtCost 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


The allocation ee partial equity method l.jpg
The Allocation EE Long-Term DebtPartial 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


The allocation ee partial equity method29 l.jpg
The Allocation EE Long-Term DebtPartial 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


The allocation ee complete equity method30 l.jpg
The Allocation EE Long-Term DebtComplete 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


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