ch05_test bank jeter advanced accounting 3rd edition

Chapter 5

Allocation and Depreciation of

Differences Between Implied and Book Value

Multiple Choice

1. When the implied value exceeds the aggregate fair values of identifiable net assets, the residual

difference is accounted for as

a. excess of implied over fair value.

b. a deferred credit.

c. difference between implied and fair value.

d. goodwill.

2. Long-term debt and other obligations of an acquired company should be valued for consolidation

purposes at their

a. book value.

b. carrying value.

c. fair value.

d. face value.

3. On January 1, 2010, Lester Company purchased 70% of Stork Corporation's $5 par common stock

for $600,000. The book value of Stork net assets was $640,000 at that time. The fair value of Stork's

identifiable net assets were the same as their book value except for equipment that was $40,000 in

excess of the book value. In the January 1, 2010, consolidated balance sheet, goodwill would be

reported at

a. $152,000.

b. $177,143.

c. $80,000.

d. $0.

4. When the value implied by the purchase price of a subsidiary is in excess of the fair value of

identifiable net assets, the workpaper entry to allocate the difference between implied and book

value includes a

1. debit to Difference Between Implied and Book Value.

2. credit to Excess of Implied over Fair Value.

3. credit to Difference Between Implied and Book Value.

a. 1

b. 2

c. 3

d. Both 1 and 2

5. If the fair value of the subsidiary's identifiable net assets exceeds both the book value and the value

implied by the purchase price, the workpaper entry to eliminate the investment account

a. debits Excess of Fair Value over Implied Value.

b. debits Difference Between Implied and Fair Value.

c. debits Difference Between Implied and Book Value.

d. credits Difference Between Implied and Book Value.

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Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd

Edition

5-2

6. The entry to amortize the amount of difference between implied and book value allocated to an

unspecified intangible is recorded

1. on the subsidiary's books.

2. on the parent's books.

3. on the consolidated statements workpaper.

a. 1

b. 2

c. 3

d. Both 2 and 3

7. The excess of fair value over implied value must be allocated to reduce proportionally the fair

values initially assigned to

a. current assets.

b. noncurrent assets.

c. both current and noncurrent assets.

d. none of the above.

8. The SEC requires the use of push down accounting when the ownership change is greater than

a. 50%

b. 80%

c. 90%

d. 95%

9. Under push down accounting, the workpaper entry to eliminate the investment account includes a

a. debit to Goodwill.

b. debit to Revaluation Capital.

c. credit to Revaluation Capital.

d. debit to Revaluation Assets.

10. In a business combination accounted for as an acquisition, how should the excess of fair value of

identifiable net assets acquired over implied value be treated?

a. Amortized as a credit to income over a period not to exceed forty years.

b. Amortized as a charge to expense over a period not to exceed forty years.

c. Amortized directly to retained earnings over a period not to exceed forty years.

d. Recognized as an ordinary gain in the year of acquisition.

11. On November 30, 2010, Pulse Incorporated purchased for cash of $25 per share all 400,000 shares

of the outstanding common stock of Surge Company. Surge 's balance sheet at November 30, 2010,

showed a book value of $8,000,000. Additionally, the fair value of Surge's property, plant, and

equipment on November 30, 2010, was $1,200,000 in excess of its book value. What amount, if any,

will be shown in the balance sheet caption "Goodwill" in the November 30, 2010, consolidated

balance sheet of Pulse Incorporated, and its wholly owned subsidiary, Surge Company?

a. $0.

b. $800,000.

c. $1,200,000.

d. $2,000,000.




Chapter 5 Allocation and Depreciation of Differences Between Implied and Book Value

5-3

12. Goodwill represents the excess of the implied value of an acquired company over the

a. aggregate fair values of identifiable assets less liabilities assumed.

b. aggregate fair values of tangible assets less liabilities assumed.

c. aggregate fair values of intangible assets less liabilities assumed.

d. book value of an acquired company.

13. Scooter Company, a 70%-owned subsidiary of Pusher Corporation, reported net income of $240,000

and paid dividends totaling $90,000 during Year 3. Year 3 amortization of differences between

current fair values and carrying amounts of Scooter's identifiable net assets at the date of the

business combination was $45,000. The noncontrolling interest in net income of Scooter for Year 3

was

a. $58,500.

b. $13,500.

c. $27,000.

d. $72,000.

14. Porter Company acquired an 80% interest in Strumble Company on January 1, 2010, for $270,000

cash when Strumble Company had common stock of $150,000 and retained earnings of $150,000.

All excess was attributable to plant assets with a 10-year life. Strumble Company made $30,000 in

2010 and paid no dividends. Porter Company’s separate income in 2010 was $375,000. Controlling

interest in consolidated net income for 2010 is:

a. $405,000.

b. $399,000.

c. $396,000.

d. $375,000.

15. In preparing consolidated working papers, beginning retained earnings of the parent company will

be adjusted in years subsequent to acquisition with an elimination entry whenever:

a. a noncontrolling interest exists.

b. it does not reflect the equity method.

c. the cost method has been used only.

d. the complete equity method is in use.

16. Dividends declared by a subsidiary are eliminated against dividend income recorded by the parent

under the

a. partial equity method.

b. equity method.

c. cost method.

d. equity and partial equity methods.





Edition

5-4

Use the following information to answer questions 17 through 20.

On January 1, 2010, Pandora Company purchased 75% of the common stock of Saturn Company. Separate

balance sheet data for the companies at the combination date are given below:

Saturn Co. Saturn Co.

Pandora Co. Book Values Fair Values

Cash $ 18,000 $155,000 $155,000

Accounts receivable 108,000 20,000 20,000

Inventory 99,000 26,000 45,000

Land 60,000 24,000 45,000

Plant assets 525,000 225,000 300,000

Acc. depreciation (180,000) (45,000)

Investment in Saturn Co. 330,000

Total assets $960,000 $405,000 $565,000

Accounts payable $156,000 $105,000 $105,000

Capital stock 600,000 225,000

Retained earnings 204,000 75,000

Total liabilities & equities $960,000 $405,000

Determine below what the consolidated balance would be for each of the requested accounts on January 2,

2010.

17. What amount of inventory will be reported?

a. $125,000

b. $132,750

c. $139,250

d. $144,000

18. What amount of goodwill will be reported?

a. ($20,000)

b. ($25,000)

c. $25,000

d. $0

19. What is the amount of consolidated retained earnings?

a. $204,000

b. $209,250

c. $260,250

d. $279,000

20. What is the amount of total assets?

a. $921,000

b. $1,185,000

c. $1,525,000

d. $1,195,000





5-5

21. Sensible Company, a 70%-owned subsidiary of Proper Corporation, reported net income of

$600,000 and paid dividends totaling $225,000 during Year 3. Year 3 amortization of differences

between current fair values and carrying amounts of Sensible's identifiable net assets at the date of

the business combination was $112,500. The noncontrolling interest in consolidated net income of

Sensible for Year 3 was

a. $146,250.

b. $33,750.

c. $67,500.

d. $180,000.

22. Primer Company acquired an 80% interest in SealCoat Company on January 1, 2010, for $450,000

cash when SealCoat Company had common stock of $250,000 and retained earnings of $250,000.

All excess was attributable to plant assets with a 10-year life. SealCoat Company made $50,000 in

2010 and paid no dividends. Primer Company’s separate income in 2010 was $625,000. The

controlling interest in consolidated net income for 2010 is:

a. $675,000.

b. $665,000.

c. $660,000.

d. $625,000.

Use the following information to answer questions 23 through 25.

On January 1, 2010, Poole Company purchased 75% of the common stock of Swimmer Company. Separate

balance sheet data for the companies at the combination date are given below:

Swimmer Co. Swimmer Co.

Poole Co. Book Values Fair Values

Cash $ 24,000 $206,000 $206,000

Accounts receivable 144,000 26,000 26,000

Inventory 132,000 38,000 60,000

Land 78,000 32,000 60,000

Plant assets 700,000 300,000 350,000

Acc. depreciation (240,000) (60,000)

Investment in Swimmer Co. 440,000

Total assets $1,278,000 $542,000 $702,000

Accounts payable $206,000 $142,000 $142,000

Capital stock 800,000 300,000

Retained earnings 272,000 100,000

Total liabilities & equities $1,278,000 $542,000

Determine below what the consolidated balance would be for each of the requested accounts on January 2,

2010.

23. What amount of inventory will be reported?

a. $170,000.

b. $177,000.

c. $186,500.

d. $192,000.





Edition

5-6

24. What amount of goodwill will be reported?

a. $26,667.

b. $20,000.

c. $42,000.

d. $86,667.

25. What is the amount of total assets?

a. $1,626,667.

b. $1,566,667

c. $1,980,000.

d. $2,006,667.





5-7

Problems

5-1 Phillips Company purchased a 90% interest in Standards Corporation for $2,340,000 on January 1,

2010. Standards Corporation had $1,650,000 of common stock and $1,050,000 of retained earnings

on that date.

The following values were determined for Standards Corporation on the date of purchase:

Book Value Fair Value

Inventory $240,000 $300,000

Land 2,400,000 2,700,000

Equipment 1,620,000 1,800,000

Required:

A. Prepare a computation and allocation schedule for the difference between the implied and book

value in the consolidated statements workpaper.

B. Prepare the January 1, 2010, workpaper entries to eliminate the investment account and allocate

the difference between implied and book value.

5-2 Pullman Corporation acquired a 90% interest in Sleeper Company for $6,500,000 on January 1

2010. At that time Sleeper Company had common stock of $4,500,000 and retained earnings of

$1,800,000. The balance sheet information available for Sleeper Company on January 1, 2010,

showed the following:


Inventory (FIFO) $1,300,000 $1,500,000

Equipment (net) 1,500,000 1,900,000

Land 3,000,000 3,000,000

The equipment had a remaining useful life of ten years. Sleeper Company reported $240,000 of net

income in 2010 and declared $60,000 of dividends during the year.

Required:

Prepare the workpaper entries assuming the cost method is used, to eliminate dividends, eliminate

the investment account, and to allocate and depreciate the difference between implied and book

value for 2010.

5-3 On January 1, 2010, Preston Corporation acquired an 80% interest in Spiegel Company for

$2,400,000. At that time Spiegel Company had common stock of $1,800,000 and retained earnings

of $800,000. The book values of Spiegel Company's assets and liabilities were equal to their fair

values except for land and bonds payable. The land's fair value was $120,000 and its book value was

$100,000. The outstanding bonds were issued on January 1, 2005, at 9% and mature on January 1,

2015. The bond principal is $600,000 and the current yield rate on similar bonds is 8%.

Required:

Prepare the workpaper entries necessary on December 31, 2010, to allocate, amortize, and

depreciate the difference between implied and book value.





Edition

5-8

Present Value

Present value of 1 of Annuity of 1

9%, 5 periods .64993 3.88965

8%, 5 periods .68058 3.99271

5-4 Pennington Corporation purchased 80% of the voting common stock of Stafford Corporation for

$3,200,000 cash on January 1, 2010. On this date the book values and fair values of Stafford

Corporation's assets and liabilities were as follows:


Cash $ 70,000 $ 70,000

Receivables 240,000 240,000

Inventories 600,000 700,000

Other Current Assets 340,000 405,000

Land 600,000 720,000

Buildings – net 1,050,000 1,920,000

Equipment – net 850,000 750,000

$3,750,000 $4,805,000

Accounts Payable $ 250,000 $250,000

Other Liabilities 740,000 670,000

Capital Stock 2,400,000

Retained Earnings 360,000

$3,750,000

Required:

Prepare a schedule showing how the difference between Stafford Corporation's implied value and

the book value of the net assets acquired should be allocated.

5-5 Perez Corporation acquired a 75% interest in Schmidt Company on January 1, 2010, for $2,000,000.

The book value and fair value of the assets and liabilities of Schmidt Company on that date were as

follows:


Current Assets $ 600,000 $ 600,000

Property & Equipment (net) 1,400,000 1,800,000

Land 700,000 900,000

Deferred Charge 300,000 300,000

Total Assets $3,000,000 $3,600,000

Less Liabilities 600,000 600,000

Net Assets $2,400,000 $3,000,000

The property and equipment had a remaining life of 6 years on January 1, 2010, and the deferred

charge was being amortized over a period of 5 years from that date. Common stock was $1,500,000

and retained earnings was $900,000 on January 1, 2010. Perez Company records its investment in

Schmidt Company using the cost method.

Required:

Prepare, in general journal form, the December 31, 2010, workpaper entries necessary to:

A. Eliminate the investment account.

B. Allocate and amortize the difference between implied and book value.





5-9

5-6 On January 1, 2010, Page Company acquired an 80% interest in Schell Company for $3,600,000.

On that date, Schell Company had retained earnings of $800,000 and common stock of $2,800,000.

The book values of assets and liabilities were equal to fair values except for the following:


Inventory $ 50,000 $ 85,000

Equipment (net) 540,000 720,000

Land 300,000 660,000

The equipment had an estimated remaining useful life of 8 years. One-half of the inventory was sold

in 2010 and the remaining half was sold in 2011. Schell Company reported net income of $240,000

in 2010 and $300,000 in 2011. No dividends were declared or paid in either year. Page Company

uses the cost method to record its investment in Schell Company.

Required:

Prepare, in general journal form, the workpaper eliminating entries necessary in the consolidated

statements workpaper for the year ending December 31, 2011.

5-7 Paddock Company acquired 90% of the stock of Spector Company for $6,300,000 on January 1,

2010. On this date, the fair value of the assets and liabilities of Spector Company was equal to their

book value except for the inventory and equipment accounts. The inventory had a fair value of

$2,300,000 and a book value of $1,900,000. The equipment had a fair value of $3,300,000 and a

book value of $2,800,000.

The balances in Spector Company's capital stock and retained earnings accounts on the date of

acquisition were $3,700,000 and $1,900,000, respectively.

Required:

In general journal form, prepare the entries on Spector Company's books to record the effect of the

pushed down values implied by the acquisition of its stock by Paddock Company assuming that:

A values are allocated on the basis of the fair value of Spector Company as a whole imputed from

the transaction.

B values are allocated on the basis of the proportional interest acquired by Paddock Company.

5-8 Pruitt Corporation acquired all of the voting stock of Soto Corporation on January 1, 2010, for

$210,000 when Soto had common stock of $150,000 and retained earnings of $24,000. The excess of

implied over book value was allocated $9,000 to inventories that were sold in 2010, $12,000 to

equipment with a 4-year remaining useful life under the straight-line method, and the remainder to

goodwill.

Financial statements for Pruitt and Soto Corporations at the end of the fiscal year ended December

31, 2011 (two years after acquisition), appear in the first two columns of the partially completed

consolidated statements workpaper. Pruitt Corp. has accounted for its investment in Soto using the

partial equity method of accounting.





Edition

5-10

Required:

Complete the consolidated statements workpaper for Pruitt Corporation and Soto Corporation for

December 31, 2011.

Pruitt Corporation and Soto Corporation

Consolidated Statements Workpaper

at December 31, 2011

Eliminations

Pruitt

Corp.

Soto

Corp. Debit Credit

Consolidated

Balances

INCOME STATEMENT

Sales 618,000 180,000

Equity from Subsidiary

Income 36,000

Cost of Sales (450,000) (90,000)

Other Expenses

(114,000) (54,000)

Net Income to Ret. Earn. 90,000 36,000

Pruitt Retained Earnings

1/1 72,000

Soto Retained Earnings

1/1 3,000

Add: Net Income 90,000 36,000

Less: Dividends (60,000) (12,000)

Retained Earnings 12/31 102,000 54,000

BALANCE SHEET

Cash 42,000 21,000

Inventories 63,000 45,000

Land 33,000 18,000

Equipment and

Buildings-net 192,000 165,000

Investment in Soto Corp. 240,000

Total Assets 570,000 249,000

LIA & EQUITIES

Liabilities 168,000 45,000

Common Stock 300,000 150,000

Retained Earnings 102,000 54,000

Total Equities 570,000 249,000





5-11

5-9 On January 1, 2010, Prescott Company acquired 80% of the outstanding capital stock of Sherlock

Company for $570,000. On that date, the capital stock of Sherlock Company was $150,000 and its

retained earnings were $450,000.

On the date of acquisition, the assets of Sherlock Company had the following values:

Fair Market

Book Value Value

Inventories ........................................................................ $ 90,000 $165,000

Plant and equipment ............................................................. 150,000 180,000

All other assets and liabilities had book values approximately equal to their respective fair market

values. The plant and equipment had a remaining useful life of 10 years from January 1, 2010, and

Sherlock Company uses the FIFO inventory cost flow assumption.

Sherlock Company earned $180,000 in 2010 and paid dividends in that year of $90,000.

Prescott Company uses the complete equity method to account for its investment in S Company.

Required:

A. Prepare a computation and allocation schedule.

B. Prepare the balance sheet elimination entries as of December 31, 2010.

C. Compute the amount of equity in subsidiary income recorded on the books of Prescott Company

on December 31, 2010.

D. Compute the balance in the investment account on December 31, 2010.

Short Answer

1. When the value implied by the acquisition price is below the fair value of the identifiable net assets

the residual amount will be negative (bargain acquisition). Explain the difference in accounting for

bargain acquisition between past accounting and proposed accounting requirements.

2. Push down accounting is an accounting method required for the subsidiary in some instances such

as the banking industry. Briefly explain the concept of push down accounting.





Edition

5-12

Questions from the Textbook

1. Distinguish among the following concepts:(a)Difference between book value and the value implied

by the purchase price.(b)Excess of implied value over fair value.(c)Excess of fair value over implied

value.(d)Excess of book value over fair value.

2. In what account is the difference between book value and the value implied by the purchase

price recorded on the books of the investor? In what account is the “excess of implied over fair

value” recorded?

3. How do you determine the amount of “the difference between book value and the value implied by

the purchase price” to be allocated to a specific asset of a less than wholly owned subsidiary?

4. The parent company’s share of the fair value of the net assets of a subsidiary may exceed acquisition

cost. How must this excess be treated in the preparation of consolidated financial statements?

5. What are the arguments for and against the alternatives for the handling of bargain acquisitions?

Why are such acquisitions unlikely to occur with great frequency?

6. P Company acquired a 100% interest in S Company. On the date of acquisition the fair value of the

assets and liabilities of S Company was equal to their book value except for land that had a fair

value of $1,500,000 and a book value of $300,000.

At what amount should the land of S Company be included in the consolidated balance sheet?

At what amount should the land of S Company be included in the consolidated balance sheet if P

Company acquired an80% interest in S Company rather than a 100%interest?

Business Ethics Question from the Textbook

Consider the following: Many years ago, a student in a consolidated financial statements class came to me

and said that Grand Central (a multi-store grocery and variety chain in Salt Lake City and surrounding towns

and cities) was going to be acquired and that I should try to buy the stock and make lots of money. I asked

him how he knew and he told me that he worked part-time for Grand Central and heard that Fred Meyer was

going to acquire it. I did not know whether the student worked in the accounting department at Grand

Central or was a custodian at one of the stores. I thanked him for the information but did not buy the stock.

Within a few weeks, the announcement was made that Fred Meyer was acquiring Grand Central and the

stock price shot up, almost doubling. It was clear that I had missed an opportunity to make a lot of money ...

I don’t know to this day whether or not that would have been insider trading. How-ever, I have never gone

home at night and asked my wife if the SEC called. From “Don’t go to jail and other good advice for

accountants,” by Ron Mano, Accounting Today, October 25, 1999.

Question: Do you think this individual would have been guilty of insider trading if he had purchased the

stock in Grand Central based on this advice? Why or why not? Are there ever instances where you think it

would be wise to miss out on an opportunity to reap benefits simply because the behavior necessitated

would have been in a gray ethical area, though not strictly illegal? Defend your position.





5-13

ANSWER KEY

Multiple Choice

1. d

2. c

3. b

4. c

5. c

6. c

7. d

8. d

9. b

10. d

11. b

12. a

13. a

14. c

15. b

16. c 21. a

17. d 22. c

18. d 23. d

19. a 24. a

20. d 25. b

Problems

5-1 A. Allocation of Difference Between Implied and Book Value

Non-

Parent Controlling Entire

Share Share Value

Purchase price and implied value $2,340,000 260,000 2,600,000

Less: Book value of equity acquired 2,430,000 270,000 2,700,000

Difference between implied and book value (90,000) (10,000) (100,000)

Inventory (54,000) (6,000) (60,000)

Land (270,000) (30,000) (300,000)

Equipment (162,000) (18,000) (180,000)

Balance (excess of FV over implied value) (576,000) (64,000) (640,000)

Gain 576,000

Increase Noncontrolling interest to fair value of assets 64,000

Total allocated bargain 640,000

Balance -0- -0- -0-

B. Common Stock – Standard 1,650,000

Beginning R/E – Standard 1,050,000

Investment in Standard Corp. 2,340,000

Difference Between Implied and Book Value 100,000

Noncontrolling Interest in Equity 260,000


Inventory 60,000

Land 300,000

Equipment 180,000

Gain on Acquisition 576,000

Noncontrolling Interest 64,000





Edition

5-14

5-2 Dividend Income (.90 × 60,000) 54,000

Dividends Declared 54,000

Beginning R/E – Sleeper 1,800,000

Common Stock – Sleeper 4,500,000

Difference Between Implied and Book Value 922,222*

Investment in Sleeper Company 6,500,000


*$6,500,000/.9 - $1,800,000 - $4,500,000 = $922,222

Allocated to: $922,222

Inventory (200,000)

Equipment (400,000)

Goodwill $ 322,222

Cost of Goods Sold 200,000

Depreciation Expense 400,000/10 40,000

Equipment 400,000– 40,000 360,000

Goodwill 322,222


5-3

Non-


Share Share Value Purchase price and implied value $2,400,000 600,000 3,000,000


Difference between implied and book value 320,000 80,000 400,000

Land ($120,000 – $100,000) (16,000) (4,000) (20,000)

Premium on Bonds Payable (623,954*– 600,000) 19,163 4,791 23,954

Balance 323,163 80,791 403,954

Goodwill (323,163) (80,791) (403,954)

Balance -0- -0- -0-

Present Value of 9% Bonds Payable discounted at 8% for 5 periods:

$600,000 × .68058 = $408,348

54,000 × 3.99271 = 215,606

$623,954*

Land 20,000

Goodwill 403,954


Interest Expense 4,084**

Unamortized Premium on Bonds Payable 19,870

(23,954 – 4,084)

**[54,000 – (623,954 × .08)]





5-15

Alternative Entries

Land 20,000

Goodwill 403,954

Premium on Bonds Payable 23,954


Premium on Bonds Payable 4,084

Interest Expense 4,084

5-4 Non-


Share Share Value Purchase price and implied value $3,200,000 800,000 4,000,000


Difference between implied and book value 992,000 248,000 1,240,000

Inventories (80,000) (20,000) (100,000)

Other Current assets (52,000) (13,000) (65,000)

Land (96,000) (24,000) (120,000)

Buildings (net) (696,000) (174,000) (870,000)

Other liabilities (56,000) (14,000) (70,000) *

Equipment (net) 80,000 20,000 100,000

Balance 92,000 23,000 115,000

Goodwill (92,000) (23,000) (115,000)

Balance -0- -0- -0-

*A debit to Other Liabilities is a reduction of their carrying value.

5-5 A. Beginning Retained Earnings (Schmidt) 900,000

Capital Stock (Schmidt) 1,500,000


Investment in Schmidt 2,000,000


B. Depreciation Expense ($400,000/6) 66,667

Equipment (net) ($400,000 – $66,667) 333,333

Land ($900,000 - $700,000) 200,000

Gain on Acquisition ($200,000+$400,000-$266,667) × 0.75 250,000


Noncontrolling Interest ($200,000+$400,000-$266,667) × 0.25 83,333





Edition

5-16

5-6 Calculations

Cost of Investment and Implied Value ($3,600,000/0.8) $4,500,000

Book Value of Equity Acquired 3,600,000

Difference between Implied and Book Value $ 900,000

Annual Adjustment in

Determining Consolidated

Net Income

Difference Between

Implied and Book Value 2010 2011

Land $360,000 --- ---

Equipment (net) 180,000 $22,500 $22,500

Inventory 35,000 17,500 17,500

Goodwill 325,000 --- ---

$900,000 $40,000 $40,000

(1) Investment in Schell 192,000

Beginning Retained Earnings (Page) 192,000

(2) Beginning Retained Earnings (Schell) 1,040,000

Difference between Implied and Book Value 900,000

Common Stock (Schell) 2,800,000

Investment in Schell ($3,600,000 +

$192,000) 3,792,000


(3) Beginning Retained Earnings – Page 32,000


Depreciation Expense 22,500

Cost of Goods Sold (Beginning Inventory) 17,500

Goodwill 325,000

Land 360,000

Equipment (net)

($180,000 – $22,500 – $22,500) 135,000

Difference between Implied and Book Value 900,000

5-7 A Net Assets

Imputed Value ($6,300,000/.9) $7,000,000

Recorded Value ($1,900,000 + $3,700,000) 5,600,000

Unrecorded Values $1,400,000

Allocate to identifiable assets

Inventory ($2,300,000 – $1,900,000) $400,000

Equipment ($3,300,000 – $2,800,000) 500,000 900,000

Goodwill $ 500,000

Inventory 400,000

Equipment 500,000

Goodwill 500,000

Revaluation Capital 1,400,000





5-17

B

Unrecorded Value Imputed by Paddock Company's

Proportionate Interest (.9 × $1,400,000) $1,260,000

Allocate to

Inventory ($2,300,000 – $1,900,000) × .9 $360,000

Equipment ($3,300,000 – $2,800,000) × .9 450,000 810,000

Goodwill $ 450,000

Inventory 360,000

Equipment 450,000

Goodwill 450,000

Revaluation Capital 1,260,000





Edition

5-18

5-8

Pruitt Corporation and Soto Corporation

Consolidated Statements Workpaper

at December 31, 2011

Eliminations

Pruitt

Corp.

Soto

Corp. Debit Credit

Consolidated

Balances

INCOME STATEMENT

Sales 618,000 180,000 798,000

Equity from Subsidiary

Income 36,000 (a) 36,000

Cost of Sales (450,000) (90,000) (540,000)

Other Expenses (114,000) (54,000) (c) 3,000 (171,000)

Net Income to Ret. Earn. 90,000 36,000 39,000 87,000

Pruitt Retained Earnings

1/1 72,000

(b) 9,000

(c) 3,000 60,000

Soto Retained Earnings

1/1 30,000 (b) 30,000

Add: Net Income 90,000 36,000 39,000 87,000

Less: Dividends (60,000) (12,000) (a) 12,000 (60,000)

Retained Earnings 12/31 102,000 54,000 81,000 12,000 87,000

BALANCE SHEET

Cash 42,000 21,000 63,000

Inventories 63,000 45,000 108,000

Land 33,000 18,000 51,000

Equipment and

Buildings-net 192,000 165,000 (b) 12,000 (c) 6,000 363,000

Investment in Soto Corp. 240,000

(a) 24,000

(b) 216,000

Goodwill (b) 15,000 15,000

Total Assets 570,000 249,000 600,000

LIA & EQUITIES

Liabilities 168,000 45,000 213,000

Common Stock 300,000 150,000 (b) 150,000 300,000

Retained Earnings 102,000 54,000 81,000 12,000 87,000

Total Equities 570,000 249,000 258,000 258,000 600,000





5-19

5-9

A.

Prescott Non- Entire

Share Controlling Value

Share Purchase price and implied value $570,000 142,500 712,500

Less: Book value of equity acquired 480,000 120,000 600,000

Difference between implied and book value 90,000 22,500 112,500

Inventories (60,000) (15,000) (75,000)

Equipment (net) (24,000) (6,000) (30,000)

Balance 6,000 1,500 7,500

Goodwill (6,000) (1,500) (7,500)

Balance -0- -0- -0-

B. Common Stock – Sherlock 150,000

Retained Earnings – Sherlock 450,000


Investment in Sherlock Company 570,000


Cost of Goods Sold 75,000

Depreciation Expense ($30,000/10 years) 3,000

Plant and Equipment ($30,000 – $3,000) 27,000

Goodwill 7,500


C. Sherlock Company net income $180,000 × 80% = $144,000

Less: Inventory sold (60,000)

Plant & equipment depreciation ( 2,400)

Equity in subsidiary income $81,600

D. Investment balance 1/1/10 $570,000

+ Equity in subsidiary income 81,600

– Dividends ($90,000 × 80%) (72,000)

Investment balance 12/31/10 $579,600

Short Answer

1. In the past, when a bargain acquisition occurred some of the acquired assets were reduced below

their fair values. Long-lived assets were recorded at fair market value less an adjustment for the

bargain. In addition, an extraordinary gain was recorded in certain instances.

Under proposed accounting requirements, no assets are reduced below fair value. Instead the credit

(negative) balance will be shown as an ordinary gain in the year of acquisition.

2. 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





Edition

5-20

Company to acquire a controlling interest in the outstanding voting stock of the subsidiary company.

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 and liabilities in its separate financial statements. Under

push down accounting, the Parent Company’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.

Solutions to Questions from the Textbook

1. a. The “difference between implied and book value” is the total difference between the value of the

subsidiary in total, as implied by the acquisition cost of an investment in that subsidiary, and the

book value of the subsidiary’s equity on the date of the acquisition (note that equity is the same as

net assets).

b. The excess of implied value over fair value, or “Goodwill,” is the excess of the value of the

subsidiary, as implied by the amount paid by the parent, over the fair value of the identifiable net assets

of that subsidiary on the date of acquisition.

c. The “excess of fair value over implied value” is the excess of the fair value of the identifiable net

assets of a subsidiary (all assets other than goodwill minus liabilities) on the acquisition date over the

value of the subsidiary as implied by the amount paid by the parent. This may be referred to as a

bargain acquisition.

d. An excess of book value over fair value describes a situation where some (or all) of the subsidiary’s

assets need to be written down rather than up (or liabilities need to be increased, or both). It does not,

however, tell us whether the acquisition results in the recording of goodwill or an ordinary gain (in a

bargain acquisition). That determination depends on the comparison of fair value of identifiable net

assets and the implied value (purchase price divided by percentage acquired), referred to in parts (b) and

(c) above.

2. The “difference between implied and book value” and the “Goodwill” are a part of the cost of an

investment and are included in the amount recorded in the investment account. Although not recorded

separately in the records of the parent company, these amounts must be known in order to prepare the

consolidated financial statements.

3. In allocating the difference between implied and book value to specific assets of a less than wholly

owned subsidiary, the difference between the fair value and book value of each asset on the date of

acquisition is reflected by adjusting each asset upward or downward to fair value (marked to market) in

its entirety, regardless of the percentage acquired by the parent company.

4. If the parent’s share of the fair value exceeds the cost, then the entire fair value similarly exceeds the

implied value of the subsidiary. This constitutes a bargain acquisition, and under proposed GAAP (ED

No. 1204-001), the excess is recorded as an ordinary gain in the period of the acquisition. Past GAAP

(APB Opinion No. 16) differed in that it provided that the excess of fair value over cost should be

allocated to reduce proportionally the values assigned to noncurrent assets with certain exceptions. If

such noncurrent assets were reduced to zero (or to the noncontrolling percentage, if there was one) by

this allocation, any remaining excess was recorded as an extraordinary gain.

5. The recording of an ordinary (or extraordinary gain) on an acquisition flies in the face of the rules of

revenue recognition because no earnings process has been completed. On the other hand, a decision to





5-21

record certain assets below their fair values is arbitrary, and also rather confusing (how far should they

be reduced?) The reason that bargain acquisitions are unlikely to occur very often is because they

suggest that the usual assumptions of an arm’s length transaction have been violated. In most

accounting scenarios, we assume that both parties are negotiating for a reasonable exchange price and

that price, once established, represents fair value both for the item given up and the item received. In

the case of a business combination, there is not a single item being exchanged but rather a number of

assets and liabilities. Nonetheless, the assumption is still that both parties are negotiating for a fair

valuation. If one party is able to obtain a bargain, it most likely indicates that the other party was being

influenced by non-quantitative considerations, such as a wish to retire quickly, health concerns, etc.

6. If P Company acquires a 100 percent interest in S Company the land will be included in the consolidated

financial statements at its fair value on the date of acquisition of $1,500,000. If P Company acquires an

80 percent interest in S Company, the land will still be included in the consolidated financial statements

at $1,500,000, and the noncontrolling interest would be charged with its share of the fair value

adjustment.

Business Ethics Solution

This case brings an interesting question to the table for discussion. As the article by Mano points out, each individual must decide for himself or herself how to respond to the gray issues that are bound to arise in life. Ultimately life is more about being at peace with ourselves and leaving a legacy of a life well-lived and values taught through our example to the generations that we leave behind us than it is about accumulating wealth (that we cannot take to the grave). The individual, had he acted on the advice, may have been guilty of insider trading as the information available to him was, apparently, not available publicly. Although there is no clear-cut definition of what constitutes insider trading, the gray area implies uncertainty; and this uncertainty can in many cases result in decisions that have severe implications both professionally and

personally.




ch05_test bank jeter advanced accounting 3rd edition

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