Solution manual advanced accounting 4e jeter ch05

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 subsidia

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CHAPTER 5

ANSWERS TO QUESTIONS

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 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

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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

7 (d) Once the determination is made that none of the assets are over-valued (and none of the liabilities under-valued), the bargain is reflected as an ordinary gain of $10,000 in the year of acquisition

8 (b) The ―excess of fair value over implied value‖ is reported as an ordinary gain under the FASB exposure draft on business combinations (ED 1204-001)

9 Under the entity theory, the noncontrolling interest shares in the adjustment of consolidated net assets for the difference between implied and book value The noncontrolling interest is also affected by the amortization or depreciation in the consolidated workpapers of the difference between implied and book value Assuming that implied value exceeds book value, the effect will generally be to lower the noncontrolling interest in reported earnings because of its (the noncontrolling interest’s) share of the excess depreciation and amortization charges, additional cost

of goods sold, impairment of goodwill, etc

ANSWERS TO BUSINESS ETHICS CASE

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

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ANSWERS TO EXERCISES

Exercise 5-1

Part A

Computation and Allocation of Difference Schedule

Parent Non- Entire Share Controlling Value

Share Purchase price and implied value $540,000 95,294 635,294 *

Less: Book value of equity acquired:

Difference between implied and book value 81,000 14,294 95,294

Less: Book value of equity acquired 450,000 150,000 600,000

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Part B Computation and Allocation of Difference Schedule

Balance (excess of FV over implied value) (15,000) (3,750) (18,750)

Increase Noncontrolling interest to fair value of assets 3,750

*$525,000/.80

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Exercise 5-4

Part A

Difference between implied and book value (10,000) (2,500) (12,500)

*$260,000/.80

Part B (1) Capital Stock- Salem Company 207,000

Beginning Retained Earnings-Salem Company 130,500

Difference between Implied and Book Value 12,500

Noncontrolling Interest in Consolidated Income

implied and book value related to

* (600,000/.80) – ($300,000 + $350,000)

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Controlling Interest in Consolidated Income

Difference between implied and book value (patent) 80,000 20,000 100,000

Difference between Implied and Book Value 120,000 120,000

* If the complete equity method is used, the debit to 1/1 Retained Earnings – Park Co would be

replaced with a debit to Investment in Sunland Company

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Difference between Implied and Book Value 200,000 200,000

* If the complete equity method is used, the debit to 1/1 Retained Earnings – Packard Co would be replaced with a debit to Investment in Sage Company

a

$400,000 (6/10) = $240,000

b

$400,000 (7/10) = $280,000

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Part A Land ($31,000/0.8) 38,750

Reduction for consolidated adjustment to fair market value (38,750)

Exercise 5-9

Part A

Share Purchase price and implied value $2,000,000 500,000 2,500,000 *

Less: Book value of equity acquired 1,760,000 440,000 2,200,000

Present Value on 1/1/2010 of 10% Bonds Payable

Discounted at 8% over 5 periods

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Unamortized Premium on Bonds Payable ($39,926 – $6,806) 33,120

Alternative entries

Exercise 5-10

Part A

Present Value on 1/2/2010 of 9% Bonds Payable

Discounted at 6% for 5 periods

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Part B Land 80,000

Unamortized Premium on Bonds Payable ($63,186 – $11,209) 51,977

Exercise 5-11

Part 1 – Cost Method

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Exercise 5-11 (continued)

To allocate and depreciate the difference between implied and book value

To establish reciprocity/convert to equity method as of 1/1/2011

To eliminate intercompany dividends

(3) Beginning Retained Earnings-Sand Company ($700,000 + $100,000 – $20,000) 780,000

Investment in Sand Company ($2,276,000 + $64,000) 2,340,000 Noncontrolling Interest ($569,000 + ($780,000 – $700,000) x 0.20) 585,000

To eliminate investment account and create noncontrolling interest account

(4) Beginning Retained Earnings-Piper Company ($36,000 + $5,000) 41,000

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2012

To establish reciprocity/convert to equity method as of 1/1/2012

(3) Beginning Retained Earnings-Sand ($780,000 + $150,000 – $30,000) 900,000

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Part 2 – Partial Equity Method

Share Purchase price and implied value $2,276,000 569,000 2,845,000

To eliminate intercompany dividends and income

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2012

Part 2 – Partial Equity Method

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Part 3 – Complete Equity Method

Share Purchase price and implied value $2,276,000 569,000 2,845,000

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Part 3 – Complete Equity Method

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(3b) Investment in Sand Company 5,000

(3) Investment in Sand Company ($41,000 + $5,000) 46,000

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Exercise 5-12

To establish reciprocity/convert to equity (0.90 ($1,250,000 – $1,000,000))

*$3,750,000/.90

Investment in Saxton Co ($3,750,000 + $225,000) 3,975,000 Noncontrolling Interest [$416,667 + ($1,250,000 – $1,000,000) x 10] 441,667

To eliminate the investment amount and create noncontrolling interest account

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Part B Palm Incorporated's Retained Earnings on 12/31/2012 $2,000,000

Palm Incorporated's share of the increase in Saxton Corporation's Retained

Earnings from acquisition date to 12/31/2012 ($1,550,000 - $1,000,000) 0.9 495,000 Less the cumulative effect to 12/31/2012 of the amortization of the difference

between implied and book value

2011 2012 Current Assets (inventory) $90,000 $0

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Exercise 5-14

Part A

To eliminate subsidiary income ($270,000)

(2) Beginning Retained Earnings-Saxton Co 1,250,000

Investment in Saxton Co ($3,750,000 + $225,000) 3,975,000 Noncontrolling Interest $416,667 + [($1,250,000 – $1,000,000) x 10] 441,667

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Less the cumulative effect to 12/31/2012 of the amortization of the difference

between implied and book value

2011 2012 Current Assets (inventory) $90,000 $0

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To eliminate subsidiary income ((.90)($300,000) - $15,000)

(2) Beginning Retained Earnings-Saxton Co 1,250,000

Noncontrolling Interest [$416,667 + ($1,250,000 – 1,000,000) x 10] 441,667

Beginning Retained Earnings-P (gain on acquisition) 300,000

Under the complete equity method, Palm’s retained earnings will equal consolidated retained earnings

Exercise 5-16

Part A

2011: Step 1: Fair value of the reporting unit $400,000

Carrying value of unit:

Carrying value of identifiable net assets $330,000 Carrying value of goodwill ($450,000 - $375,000) 75,000

405,000 Excess of carrying value over fair value $ 5,000 The excess of carrying value over fair value means that step 2 is required

Step 2: Fair value of the reporting unit $400,000

Fair value of identifiable net assets 340,000

Recorded value of goodwill ($450,000 - $375,000) 75,000

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380,000 Excess of fair value over carrying value $ 20,000

The excess of fair value over carrying value means that step 2 is not required

360,000 Excess of carrying value over fair value $ 10,000 The excess of carrying value over fair value means that step 2 is required

Step 2: Fair value of the reporting unit $350,000

Fair value of identifiable net assets 325,000

Recorded value of goodwill ($75,000 - $15,000) 60,000

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ANSWERS TO PROBLEMS

Problem 5-1

Calculations:

Difference between implied and book value 1,600,000 400,000 2,000,000

(1) Beginning Retained Earnings-Santos Co 1,000,000

Difference between Implied and Book Value 2,000,000

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2012

(1) Investment in Santos Company ($300,000 0.80) 240,000

To establish reciprocity/convert to equity as of 1/1/2012

(2) Beginning Retained Earnings-Santos Company 1,300,000

Difference between Implied and Book Value 2,000,000

Investment in Santos Company ($2,800,000 + $240,000) 3,040,000 Noncontrolling Interest $700,000 + [($1,300,000 – $1,000,000) x 0.20] 760,000

To eliminate investment account

(3) Beginning Retained Earnings-Palmero Co 72,000

Property and Equipment (net) ($900,000 - $90,000 - $90,000) 720,000

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Problem 5-1 (continued)

Part B Controlling Interest in Consolidated Net Income 2011 2012

Palmero Company's Net Income from Independent Operations $400,000 $425,000 Palmero Company's Share of Reported Income of Santos Company 240,000 320,000 Less: Depreciation of Difference between

Implied and Book Value

Allocated to:

Controlling Interest in Consolidated Net Income $568,000 $673,000

Noncontrolling Interest in Consolidated Income (2011)

Controlling Interest in Consolidated Income (2011)

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Unamortized Discount on Bonds Payable (106,143) (45,490) (151,633)

Amortization of amount of difference between implied and book value allocated to unamortized

discount on bonds payable

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Part A 2011

(1) Equity in Subsidiary Income (.70)($100,000) 70,000

To eliminate subsidiary income

(2) Beginning Retained Earnings-Sagon Co 500,000

To allocate and amortize the difference between Implied and book value

(1) Equity in Subsidiary Income (.70)($120,000) 84,000

To eliminate subsidiary income

(2) Beginning Retained Earnings-Sagon Company 600,000

Investment in Sagon Company ($1,300,000 + $70,000) 1,370,000 Noncontrolling Interest ($557,143 + ($600,000 – $500,000) x 0.30) 587,143

To eliminate the investment account and create noncontrolling interest account

(3) Beginning Retained Earnings-Paxton Company 17,386 *

Unamortized Discount on Bonds Payable ($151,633 - $24,837 - $27,320) 99,476

To allocate and amortize the difference between implied and book value

*$24,837 x 70% = $17,386

Alternative to entry (3)

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(3a) Unamortized Discount on Bonds Payable 151,633

(3b) Beginning Retained Earnings-Paxton Company 17,386

Carrying value of identifiable net assets $1,409,000 Carrying value of goodwill 205,510

1,614,510 Excess of carrying value over fair value $ 114,510 The excess of carrying value over fair value means that step 2 is required

Step 2: Fair value of the reporting unit $1,500,000

Fair value of identifiable net assets 1,320,000

Part B Controlling Interest in Consolidated Net Income 2011 2012

Paxton Company's Net Income from Independent Operations $300,000 $250,000 Paxton Company's Share of Reported Income of Sagon Company 70,000 84,000 Less: Amortization of Difference between Implied and Book Value

Allocated to:

Controlling Interest in Consolidated Net Income $352,614 $314,876

* $27,320 x 70% = $19,124

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2013

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Part B 2012

(1) Equity in Subsidiary Income ((.80)($750,000) - $80,000) 520,000

To eliminate intercompany income and dividends

(2) Beginning Retained Earnings - Superstition Company 600,000

To eliminate intercompany income and dividends

(2) Beginning Retained Earnings-Superstition Company 1,200,000

Investment in Superstition Company ($1,970,000 + $480,000) 2,450,000 Noncontrolling Interest ($492,500 + ($1,200,000 – $600,000) x 20) 612,500

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(3) Investment in Superstition Company

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Problem 5-4

Part A

Share Purchase price and implied value $850,000 212,500 1,062,500 *

Part B and C – Worksheet Entries

Cost Method Workpaper entries – Year 2010

To allocate the difference between implied and book value

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Cost Method – Worksheet Entries – Year 2011

(1) Investment in Salem Company (.80 ($100,000 - $25,000)) 60,000

To establish reciprocity/convert to equity as of 1/1/2011

(3) Beginning Retained Earnings - Salem Co.($80,000 + $100,000 – $25,000) 155,000

Noncontrolling Interest ($212,500 + ($155,000 – $80,000) 2) 227,500

(5) 1/1 Retained Earnings – Porter Company (previous year’s amount) 20,800

Partial Equity Method Workpaper entries – Year 2010

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Partial Equity Method – Worksheet Entries – Year 2011

Investment in Salem Company ($850,000 + $80,000 – $20,000) 910,000 Noncontrolling Interest ($212,500 + ($155,000 – $80,000) 2) 227,500

(4) 1/1 Retained Earnings – Porter Company (previous year’s amount) 20,800

Complete Equity Method Workpaper entries – Year 2010

(1) Equity in Subsidiary Income ($100,000)(.80) – $32,000 – $20,800 27,200

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(2) Beginning Retained Earnings - Salem Co 80,000

Complete Equity Method – Worksheet Entries – Year 2011

(1) Equity in Subsidiary Income ($110,000)(.80) - $20,800 67,200

(2) Beginning Retained Earnings - Salem Co ($80,000 + $75,000) 155,000

Investment in Salem Company ($850,000 + $80,000 – $20,000) 910,000 Noncontrolling Interest ($212,500 + ($155,000 – $80,000) 2) 227,500

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Net Income to Retained Earnings $148,000 $170,000 $121,500 $19,300 $177,200

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Porter Salem Eliminations Noncontrolling Consolidated

Investment in Salem Company 850,000 (1) 120,000 (3) 970,000

Difference between Implied and Book Value (3) 432,500 (4a) 432,500

1/1 Noncontrolling Interest in Net (4a) 8,000 (3) 242,500 ** 224,100

12/31 Noncontrolling Interest in Net

Assets

Total Liabilities and Equity $1,780,000 $1,030,000 $1,938,500 $1,938,500 $2,227,000

* Noncontrolling Interest in Income =.2 $170,000 – (.2 x $26,000) – (.2 x $47,500) = $19,300

** $212,500 + ($230,000 – $80,000) x 20 = $242,500

Explanations of workpaper entries are on the following page

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