ADVANCEDACCOUNTING

International Student Version

Fifth Edition

Debra C. Jeter

Paul K. Chaney

John Wiley & Sons, Inc.

CONTENTS

INTRODUCTION TO BUSINESS COMBINATIONSAND THE CONCEPTUAL FRAMEWORK

Learning Objectives 1Planning M&A in a Changing Environment and Under ChangingAccounting Requirements 4Nature of the Combination 5Business Combinations: Why? Why Not? 7Business Combinations: Historical Perspective 10Terminology and Types of Combinations 14Takeover Premiums 17Avoiding the Pitfalls before the Deal 18Determining Price and Method of Payment in Business Combinations 20Alternative Concepts of Consolidated Financial Statements 25FASB's Conceptual Framework 29FASB Codification (Source of GAAP) 36Summary 41Appendix: Evaluating Firm Performance 42Questions 49Analyzing Financial Statements 49Exercises 51ASC (Accounting Standards Codification) Exercises 53

ACCOUNTING FOR BUSINESS COMBINATIONS

Learning Objectives 54Historical Perspective on Business Combinations 54Pro Forma Statements and Disclosure Requirement 63Explanation and Illustration of Acquisition Accounting 65Contingent Consideration in an Acquisition 70Leveraged Buyouts 75IFRS versus U.S. GAAP 76Summary 77Appendix A: Deferred Taxes in Business Combinations 79

5 4

I X

Contents

Questions 81Analyzing Financial Statements 82Exercises 84ASC Exercises 90Problems 91

CONSOLIDATED FINANCIAL STATEMENTS-DATE OF ACQUISITION 96

Learning Objectives 96Definitions of Subsidiary and Control 98Requirements for the Inclusion of Subsidiaries in the ConsolidatedFinancial Statements 102Reasons for Subsidiary Companies 103Consolidated Financial Statements 103 '*Investments at the Date of Acquisition 105Consolidated Balance Sheets: The Use of Workpapers 106A Comprehensive Illustration—More than One Subsidiary Company 123Limitations of Consolidated Statements 125Summary 128Appendix A: Deferred Taxes on the Date of Acquisition 129Accounting for Uncertain Tax Positions 130Appendix B: Consolidation of Variable Interest Entities 132Questions 134Analyzing Financial.Statements 135Exercises 136ASC Exercises 141Problems 142

CONSOLIDATED FINANCIAL STATEMENTSAFTER ACQUISITION 149

Learning Objectives 149Accounting for Investments by the Cost, Partial Equity,and Complete Equity Methods 150Consolidated Statements after Acquisition—Cost Method 158Recording Investments in Subsidiaries—Equity Method(Partial or Complete) 170Elimination of Intercompany Revenue and Expense Items 180Interim Acquisitions of Subsidiary Stock 182Consolidated Statement of Cash Flows 194Illustration of Preparation of a Consolidated Statementof Cash Flows—Year of Acquisition 197Compare U.S. GAAP and IFRS Regarding Equity Method 201

Contents xi

Summary 202Appendix A: Alternative Workpaper Format 203Appendix B: Deferred Tax Consequences When Affiliates FileSeparate Income Tax Returns—Undistributed Income 205Consolidated Tax Returns—Affiliated Companies(80% or More Ownership Levels) 206Separate Tax Returns—Deferred Tax Consequences ArisingBecause of Undistributed Subsidiary Income 206The Cost Method—Separate Tax Returns 207Undistributed Income Is Expected to Be RealizedWhen the Subsidiary Is Sold 209The Partial and Complete Equity Methods—Separate Tax Returns 209Questions 211Analyzing Financial Statements 212Exercises 214ASC Exercises 220Problems 221

ALLOCATION AND DEPRECIATION OF DIFFERENCESBETWEEN IMPLIED AND BOOK VALUES 234

Learning Objectives 234Allocation of the Difference Between Implied and Book Values to Assetsand Liabilities of Subsidiary—Acquisition Date 236Effect of Allocation and Depreciation of Differences Between Implied and BookValues on Consolidated Net Income—Year Subsequent to Acquisition 243Consolidated Statements Workpaper—Investment RecordedUsing the Cost Method 248Cost Method Analysis of Controlling and Noncontrolling Interestsin Consolidated Net Income and Retained Earnings 257Consolidated Statements Workpaper—Investment Recorded UsingPartial Equity Method 259Partial Equity Method Analysis of Controlling and NoncontrollingInterests in Consolidated Net Income and Retained Earnings 267Consolidated Statements Workpaper—Investment Recorded UsingComplete Equity Method 269Complete Equity Method Analysis of Controlling Interestin Consolidated Net Income and Retained Earnings 277Additional Considerations Relating to Treatment of DifferenceBetween Implied and Book Values 278Push Down Accounting 287IFRS vs. U.S. GAAP on Research & Development Costs 292Summary 293Questions 294Analyzing Financial Statements 296

xii Contents

Exercises 297ASC Exercises 303Problems 303

ELIMINATION OF UNREALIZED PROFITON INTERCOMPANY SALES OF INVENTORY 320

Learning Objectives 320Effects of Intercompany Sales of Merchandise on the Determinationof Consolidated Balances 321Cost Method: Consolidated Statements Workpaper—Upstream Sales 331Cost Method—Analysis of Consolidated Net Income and ConsolidatedRetained Earnings 337Consolidated Statements Workpaper—Partial Equity Method 340Partial Equity Method—Analysis of Consolidated Net Income and ConsolidatedRetained Earnings 344 ̂ '"Consolidated Statements Workpaper—Complete Equity Method 345Complete Equity Method—Analysis of Consolidated Net Incomeand Consolidated Retained Earnings 350Summary of Workpaper Entries Relating to Intercompany Sales of Inventory 350Intercompany Profit Prior to Parent-Subsidiary Affiliation 351Summary 352Appendix: Deferred Taxes and Intercompany Sales of Inventory 353Deferred Tax Consequences Arising Because of UnrealizedIntercompany Profit 353Intercompany Sales of Inventory—Cost and Partial Equity Method 354Undistributed Subsidiary Income—Impact of UnrealizedIntercompany Profit on the Calculation of Deferred Taxes 356Questions 359Analyzing Financial Statements 360Exercises 362ASC Exercises 365Problems 365

ELIMINATION OF UNREALIZED GAINSOR LOSSES ON INTERCOMPANY SALESOF PROPERTY AND EQUIPMENT 380

Learning Objectives 380Intercompany Sales of Land (Nondepreciable Property) 381Intercompany Sales of Depreciable Property (Machinery,Equipment, and Buildings) 384Consolidated Statements Workpaper—Cost and Partial Equity Methods 392Calculation of Consolidated Net Income and ConsolidatedRetained Earnings 401Consolidated Statements Workpaper—Complete Equity Method 405

Contents xiii

Calculation and Allocation of Consolidated Net Income; Consolidated RetainedEarnings: Complete Equity Method 411Summary of Workpaper Entries Relating to IntercompanySales of Equipment 411Intercompany Interest, Rents, and Service Fees 411Summary 415Appendix: Deferred Tax Consequences Related to Intercompany Salesof Equipment 416Impact of Unrealized Intercompany Profit on the Calculation of DeferredTax Consequences Related to Undistributed Subsidiary Income 418Calculations (and Allocation) of Consolidated Net Income and ConsolidatedRetained Earnings 419Questions 421Analyzing Financial Statements 421Exercises 422 "*ASC Exercises 425Problems 425

CHANGES IN OWNERSHIP INTEREST 437

Learning Objectives 437Parent Acquires Subsidiary Stock Through Several Open-MarketPurchases—Cost Method 439Parent Sells Subsidiary Stock Investment on the Open Market—Cost Method 443Equity Method—Purchases and Sales of Subsidiary Stock by the Parent 447Parent Sells Subsidiary Stock Investment on the Open Market—Cost Method 451Subsidiary Issues Stock 453Summary 463Questions 464Analyzing Financial Statements 464Exercises 465ASC Exercises 468Problems 468

INTERCOMPANY BOND HOLDINGS ANDMISCELLANEOUS TOPICS—CONSOLIDATEDFINANCIAL STATEMENTS — 477

Learning Objectives 477Intercompany Bond Holdings 478Accounting for Bonds—A Review 479Constructive Gain or Loss on Intercompany Bond Holdings 480Accounting for Intercompany Bonds Illustrated 483Book Entry Related to Bond Investment 484Interim Purchase of Intercompany Bonds 500

xiv Contents

Notes Receivable Discounted 501Stock Dividends Issued by a Subsidiary Company 503Dividends from Preacquisition Earnings 507Subsidiary with Both Preferred and Common Stock Outstanding 508Consolidating a Subsidiary with Preferred Stock Outstanding 511Summary 522

1 Questions 523Analyzing Financial Statements 524Exercises 526

\ ASC Exercises 530Problems 530

INSOLVENCY—LIQUIDATION AND REORGANIZATION 542

Learning Objectives 542,^ *Contractual Agreements 543Bankruptcy 545Liquidation (Chapter 7) 550Reorganization Under the Reform Act (Chapter 11) 551Trustee Accounting and Reporting 562Realization and Liquidation Account 565Summary 571Questions 572Analyzing Financial Statements 572Exercises 577ASC Exercises 581Problems 581

INTERNATIONAL FINANCIALREPORTING STANDARDS 588

Learning Objectives 588The Increasing Importance of International Accounting Standards 588The Road to Convergence—U.S. GAAP and IFRS 589Significant Similarities and Differences Between U.S. GAAP and IFRS 594GAAP Hierarchy—U.S. versus IFRS 595Long-Term Convergence Issues—FASB and IASB 605Lease Accounting Convergence 605Revenue Recognition Convergence 607Financial Statement Presentation 609Potential Changes to Financial Statements 610International Convergence Issues 614American Depository Receipts: An Overview 617Summary 620

Contents X V

Appendix A: List of Current International Financial Reporting Standards, Issuedby IASC and IASB 621Questions 622Analyzing Financial Statements 623Exercises 625ASC Exercises 627Problems 627

ACCOUNTING FOR FOREIGN CURRENCYTRANSACTIONS AND HEDGING FOREIGN

» EXCHANGE RISK 631

Learning Objectives 631Exchange Rates—Means of Translation 632Measured versus Denominated 635Foreign Currency Transactions 635Using Forward Contracts as a Hedge 645Summary 664Questions 665Analyzing Financial Statements 666Exercises 666ASC Exercises 674Problems 674

TRANSLATION OF FINANCIAL STATEMENTSOF FOREIGN AFFILIATES 682

Learning Objectives 682Accounting for Operations in Foreign Countries 683Translating Financial Statements of Foreign Affiliates 684Objectives of Translation—SFAS No. 52 [ASC 830-30] 685Translation Methods 686Identifying the Functional Currency 687Translation of Foreign Currency Financial Statements 689Translation of Foreign Financial Statements Illustrated 693Financial Statement Disclosure 702Historical Developments of Accounting Standards 704Summary 706Appendix: Accounting for a Foreign Affiliate and Preparation of ConsolidatedStatements Workpaper Illustrated 707Date of Acquisition 707Accounting for an Investment in a Foreign Affiliate—After Acquisition 708Consolidation When the Temporal Method of Translation Is Used 709Remeasurement and Translation of Foreign Currency Transactions 711Intercompany Receivables and Payables 712

XVI Contents

Elimination of Intercompany Profit 712Liquidation of a Foreign Investment 713Questions 714Analyzing Financial Statements 714Exercises 716ASC Exercises 723

1 Problems 723

REPORTING FOR SEGMENTS ANDFOR INTERIM FINANCIAL PERIODS 733

Learning Objectives 733Need for Disaggregated Financial Data 734Standards of Financial Accounting and Reporting 734International Accounting Standards Board (IASB) PositionOn Segment Reporting 746Interim Financial Reporting 747Summary 756Appendix: GE Segmental Disclosures, 2010 Annual Report (partial) 758Basic for Presentation 760Questions 761Exercises 764ASC Exercises 768Problems 768

PARTNERSHIPS: FORMATION, OPERATION,AND OWNERSHIP CHANGES 773

Learning Objectives 773Partnership Defined 774Reasons for Forming a Partnership 776Characteristics of a Partnership 776Partnership Agreement 779Accounting for a Partnership 780Special Problems in Allocation of Income and Loss 788Financial Statement Presentation 790Changes in the Ownership of the Partnership 791Section A: Admission of a New Partner 793Section B: Withdrawal of a Partner 800Summary 804Questions 805Exercises 806ASC Exercises 812Problems 813

Contents xvii

PARTNERSHIP LIQUIDATION 820

Learning Objectives 820Steps in the Liquidation Process 821Priorities of Partnership and Personal Creditors 823Simple Liquidation Illustrated 825Installment Liquidation 827Incorporation of a Partnership 836Summary 838Questions 839Exercises 839ASC Exercises 844Problems 845

Glossary G-l ,jAppendix ASC: Researching the FASB Codification A-lAppendix PV: Tables of Present Value A-8Index 1-1