7.
FASB ASC 323-10-15 requires the use of the equity method of accounting for an investor whose investment in voting stock gives it the ability to exercise significant influence over operating and financial policies of an investee. Section 15-6 states that “Ability to exercise significant influence over operating and financial policies of an investee may be indicated in several ways, including the following: Representation on the board of directors, Participation in policy-making processes, Material intra-entity transactions, change of managerial personnel, Technological dependency, and Extent of ownership by an investor in relation to the concentration of other shareholdings (but substantial or majority ownership of the voting stock of an investee by another investor does not necessarily preclude the ability to exercise significant influence by the investor)” (emphasis added). It is clear, in this case, that the investee is critically dependent upon the technology licensed to it by the investor. The investor should, therefore, account for its investment using the equity method.
8.
Even though the investor owns 30% of the investee, it should not use the equity method as it cannot exert significant influence over the investee. Further, since the investee is not a public company (all of the remaining stock is privately held), the investor should use the cost method to account for this investment as the fair value method presumes a publicly traded stock with sufficient liquidity to reasonably determine a fair value.
9.
a. The losses did not affect Enron’s income statement. Since the investees were insolvent, Enron’s Equity Investment was reduced to zero (it had not made any loans or other advances to the investee companies). As a result, Enron discontinued reporting for these Equity Investments using the equity method and, therefore, did not recognize its proportionate share of investee losses. b. “… only after its share of that net income equals the share of net losses not recognized during the period the equity method was suspended” means that the investee has recouped all of the losses that have been reported. Since the investor ceases to account for its Equity Investment using the equity method once the balance reaches zero (assuming that it has not guaranteed the debts of the investee company), this generally implies that the investee’s Stockholders’ Equity is below zero (i.e., a deficit). The investor resumes its accounting for the Equity investment using the equity method once the investee’s Stockholders’ Equity is positive. It is at that point when the investee company has recouped all of its prior losses (assuming that the investee company has not raised additional equity capital).
Solutions Manual, Chapter 1
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10.
FASB ASC 323 provides the following list of required disclosures for equity method investments: a. (1) the name of each investee and percentage of ownership of common stock, (2) the accounting policies of the investor with respect to investments in common stock, and (3) the difference, if any, between the amount at which an investment is carried and the amount of underlying equity in net assets and the accounting treatment of the difference. b. For those investments in common stock for which a quoted market price is available, the aggregate value of each identified investment based on the quoted market price usually should be disclosed. This disclosure is not required for investments in common stock of subsidiaries. c. When investments in common stock of corporate joint ventures or other investments accounted for under the equity method are, in the aggregate, material in relation to the financial position or results of operations of an investor, it may be necessary for summarized information as to assets, liabilities, and results of operations of the investees to be presented in the notes or in separate statements, either individually or in groups, as appropriate. d. Conversion of outstanding convertible securities, exercise of outstanding options and warrants and other contingent issuances of an investee may have a significant effect on an investor's share of reported earnings or losses. Accordingly, material effects of possible conversions, exercises or contingent issuances should be disclosed in notes to the financial statements of an investor.
11.
Answer: d The fact that the investor has a 20% voting interest, representation on the investee’s board of directors, participates in the investee’s policy making process and has material business transactions with the investee all suggest that the investor has “significant influence” over the investee. In the case of significant influence, the investor must use the equity method of accounting for the investee. Under the equity method, the investee recognizes as income a proportionate share of the net income recognized by the investee.
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Advanced Accounting, 4th Edition
12.
Answer: b The indicators of significant influence include: investor representation on the board of directors of the investee, investor participation in policy making processes of the investee, the extent of ownership of investee voting shares by the investor in relation to the concentration of other shareholdings, material intercompany transactions between the investor and the investee, interchange of managerial personnel between the investor and the investee, and technological dependency of the investee on the investor. Indications that an investor does not have significant influence includes the investor surrendering significant rights in the investee, a concentrated group of owners of the investee who do not consider the views of the investor and a lack of representation on the investee’s board of directors.
13.
Answer: a Application of the equity method of investment accounting results in an increase in the investment account for positive net income (i.e., a decrease of net losses) and a decrease in the investment account for dividends. The company paying dividends decreases retained earnings for dividends. A company applying the fair value method or the cost-based approach will recognize as income dividends received.
14.
Answer: b When an investor can exert significant influence over an investee, the investor must use the equity method for the Equity Investment. Under the equity method, the investee recognizes as income a proportionate share of the net income recognized by the investee. In addition, if the investor paid an amount different from a proportionate share of the book value of the investee and/or if the fair values of the individual investee net assets differ from their book values, then the investor might also have to adjust equity income for the amortization of the excess. In this case, the proportionate share of the investee book value (i.e., $2,000,000 x 30%) equals the amount paid for the 30% interest (i.e., $600,000), and all individual net assets had appraised fair values that equaled their reported book values. Thus, the Equity Investment carrying value at December 31, 2019 is determined as follows: Initial Equity Investment balance at 12/31/2018 2018 share of investee net income (30% x $120,000) 2018 share of investee dividends (30% x $50,000) 2019 share of investee net income (30% x $120,000) 2019 share of investee dividends (30% x $50,000) Equity Investment balance at 12/31/2019
Solutions Manual, Chapter 1
$ 600,000 36,000 (15,000) 36,000 (15,000) $ 642,000
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15.
Answer: c The fair value method is used for reporting noncontrolling investments in equity securities that (1) do not convey to the holder of the securities “significant influence” over the investee and (2) have a readily determinable fair value. Under the fair value method, the investment is reported by the investor at the fair value of the investment on the reporting date. (Assuming the investment is not considered impaired. There is no evidence of impairment in the present problem.) Thus, at December 31, 2019, the investment is reported at $288,000 (i.e., $16 x 18,000 shares on December 31, 2019). (The following is not addressed in the problem. We are providing this discussion for completeness. Noncontrolling investments in equity securities that do not have a readily determinable fair value and also do not convey to the holder of the securities “significant influence” over the investee are reported in the balance sheet at the original cost of the investment.)
16.
Answer: b The equity method is used for reporting noncontrolling investments in equity securities that convey to the holder of the securities “significant influence” over the investee. Under the equity method, the investment is reported by the investor at the original cost of the investment and then is adjusted for the investor’s ownership percentage of all of the items that change the stockholders’ equity of the investee. (Most textbook problems in intermediate accounting and advanced accounting assume that the only changes to the stockholders’ equity of the subsidiary are net income and dividends.) In addition, any unrecorded net assets implicit in the investment are amortized. In this case, the AAP is zero because the fair value of the consideration equals the book value of the proportionate share of the investee’s net assets, and fair values of the individual identifiable net assets approximate book values. The December 31, 2019 balance is determined as follows: Beginning Investment ($12 x 18,000 shares) Plus: p% x NI (20% x $50,000) Less: p% x Dividends (20% x $15,000) Ending Investment
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$ 216,000 10,000 (3,000) $ 223,000
Advanced Accounting, 4th Edition
17.
Answer: b A cost-based approach is used for reporting noncontrolling investments in equity securities that (1) do not convey to the holder of the securities “significant influence” over the investee and (2) do not have a readily determinable fair value. Under the costbased approach, the investment is reported by the investor at the original cost of the investment. (Assuming the investment is not considered impaired. There is no evidence of impairment in the present problem.) Thus, at December 31, 2019, the investment is reported at $352,000 (i.e., $11 x 32,000 shares purchased on January 1, 2019.). (The following is not addressed in the problem. We are providing this discussion for completeness. Noncontrolling investments in equity securities are reported in the balance sheet at fair value if they have a readily determinable fair value and also do not convey to the holder of the securities “significant influence” over the investee. The change in fair value is reported in net income.)
18.
Answer: c The equity method is used for reporting noncontrolling investments in equity securities that convey to the holder of the securities “significant influence” over the investee. Under the equity method, the investment is reported by the investor at the original cost of the investment and then is adjusted for the investor’s ownership percentage of all of the items that change the stockholders’ equity of the investee. (Most textbook problems in intermediate accounting and advanced accounting assume that the only changes to the stockholders’ equity of the subsidiary are net income and dividends.) In addition, any acquisition premium implicit in the investment is amortized if the asset net assets causing the premium are amortizable (e.g., property and equipment). In this case, the 24% AAP is equal to $88,000 ($352,000 fair value of consideration paid for 24% [see answer to #17] less 24% x book value of net assets (i.e., $264,000 = 24% x $1,100,000). The only depreciable asset in the 24% AAP is the customer list, which has $21,600 of AAP assigned to it (i.e., 24% x $90,000). This results in 24% AAP amortization of $4,320 per year (i.e., $21,600/5). The December 31, 2019 equity-method investment balance is determined as follows: Beginning Investment ($11 x 32,000 shares) Plus: p% x NI (24% x $120,000) Less: p% x Dividends (24% x $40,000) Less: p% AAP amortization Ending Investment
Solutions Manual, Chapter 1
$ 352,000 28,800 (9,600) (4,320) $ 366,880
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19.
Correct: b When an investor company has significant influence over an investee company, the investor must use the equity method. Under the equity method, the investor will recognize as part of its net income a proportionate share of the net income of the investor. The income recognized by the investor must be reduced for a proportionate share of the gross profit for intercompany transactions that occurred during the current period, but that will not be part of a transaction with an unaffiliated party until a future period. In this case, at the end of the period, the investee is still holding $20,000 of inventory it purchased from the investor. Given that the gross profit percentage is 40%, this means $8,000 of the inventory balance is intercompany profits. The investor must defer its proportionate share of this amount, so $2,400 will be deducted from the equity method income recognized by the investor. This means equity method income is equal to $9,600 (i.e., (30% x $40,000) - $2,400 = $9,600).
20.
Correct: a When an investor company has significant influence over an investee company, the investor must use the equity method. Under the equity method, the investor will recognize as part of its net income a proportionate share of the net income of the investor. The income recognized by the investor must be reduced for a proportionate share of the gross profit for intercompany transactions that occurred during the current period, but that will not be part of a transaction with an unaffiliated party until a future period. In addition, income of the current period will be increased by any gross profit from prior period intercompany transactions that are realized in the current period via transactions with unaffiliated parties. In this case, at the end of the period, the investee is still holding $40,000 of inventory it purchased from the investor. Given that the gross profit percentage is 25%, this means $10,000 of the ending inventory balance is intercompany profits. In addition, at the beginning of the period, the investee held $30,000 of inventory it purchased from the investor. Given that the gross profit percentage is 25%, this means $7,500 of the beginning inventory balance is intercompany profits. The investor must defer its proportionate share of the ending profits in inventory and recognize in the current year its proportionate share of the beginning profits in inventory; thus, $3,000 (i.e., 30% x $10,000) will be deducted from the equity method income recognized by the investor and $2,250 (i.e., 30% x $7,500) will be added to the equity method income recognized by the investor. This means equity method income is equal to $17,250 (i.e., (30% x $60,000) - $3,000 + $2,250 = $17,250).
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Advanced Accounting, 4th Edition
21.
Correct: b When an investor company has significant influence over an investee company, the investor must use the equity method. Under the equity method, the investor will recognize as part of its net income a proportionate share of the net income of the investor. The income recognized by the investor must be reduced for a proportionate share of the gross profit for intercompany transactions that occurred during the current period, but that will not be part of a transaction with an unaffiliated party until a future period. In addition, income of the current period will be increased by any gross profit from prior period intercompany transactions that are realized in the current period via transactions with unaffiliated parties. The investment account will be reduced by the dividends received from the investee. The investment account at December 31, 2019 is computed as follows:
+ + + -
22.
Beginning balance at January 1, 2018 30% x NI of Investee during 2018 (30% x $50,000) 30% of 2018 profit deferred to 2019 (30% x (25% x $30,000)) 2018 dividends received (30% x $10,000) 30% x NI of Investee during 2019 (30% x $60,000) 30% of 2019 profit deferred to 2020 (30% x (25% x $40,000)) 30% of profit from 2018 recognized in 2019 (30% x (25% x $30,000)) 2019 dividends received (30% x $15,000) Ending balance at December 31, 2019
$525,000 15,000 (2,250) (3,000) 18,000 (3,000) 2,250 (4,500) $547,500
Answer: d When an investor company has significant influence over and investee, it must use the equity method of accounting. When the investor ceases to have significant influence, it must determine if the investee company’s common stock has a readily determinable fair value. If it does not have a readily determinable fair value, the investor must use a costbased approach to account for the remaining Equity Investment. If it does have a readily determinable fair value, the investor must use the fair value method to account for the remaining Equity Investment. In this case, the investee has a readily determinable fair value, so the investment must be carried at its current fair value. Based on the information, the best proxy for the current fair value of the remaining 10% investment is the selling price of the 10% interest sold to an unaffiliated party.
Solutions Manual, Chapter 1
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23.
a. The investor reports equity income equal to its proportionate share of the net income of the investee company: $400,000 x 30% = $120,000. b. The balance of the Equity Investment account at the end of the year is $560,000 ($500,000 + $120,000 - $60,000). c. The fair value of the investee company is not reflected in the financial statements of the investor company. Under the equity method, the Equity Investment account is reported after adjusting for equity income and dividends. Changes in the fair value of the investee company do not affect this reported amount (unless the fair value declines below the carrying amount of the Equity Investment and the decline is deemed to be other than temporary). The fair value should be disclosed in the notes to the financial statements.
24.
FASB ASC 323-10-35-18 requires equity method investors to “record its proportionate share of the investee’s equity adjustments for other comprehensive income … as increases or decreases to the investment account with corresponding adjustments in equity.” Thus, the investee’s net income will affect the equity method income recognized as part of the investor’s net income, and the investee’s portion of other comprehensive income (OCI) items will directly affect the investor’s OCI items (i.e., not net income). Both the net income and OCI components (i.e., total comprehensive income) will affect the Equity Investment account. a. $600,000 x 40% = $240,000 b. $750,000 + (40% x $700,000) – $80,000 = $950,000
25.
a. Equity investment
120,000 Cash
120,000
(to record the purchase of the Equity Investment)
b. Equity investment
20,000 Equity income
20,000
(to record equity income)
c. Cash
12,000 Equity investment
12,000
(to record receipt of the cash dividend)
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Advanced Accounting, 4th Edition
d. Cash
150,000 Equity investment* Gain on sale
128,000 22,000
(to record the sale of the Equity Investment) * Equity Investment balance on date of sale = $120,000 + $20,000 - $12,000 = $128,000
26.
a. The gross profit remaining in ending inventory = $40,000 x 15% = $6,000. Equity income = ($100,000 - $6,000) x 30% = $28,200 b. Beginning Equity Investment Equity income Dividends Ending Equity Investment
$400,000 28,200 (18,000) $410,200
c. Equity income = ($150,000 + $6,000) x 30% = $46,800
27. a. Equity investment Equity Income (recognize 25% of net income = 25% x $400,000)
100,000 100,000
Equity Income Equity investment (Defer profits in ending inventory = 25% x 30% x $120,000)
9,000
Cash
25,000
9,000
Equity investment (record receipt of dividends)
25,000
b. Ending investment = $1,000,000 + $100,000 - $9,000 - $25,000 = $1,066,000 c. Equity income in following year = (25% x $450,000) + $9,000 = $121,500
Solutions Manual, Chapter 1
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28.
a. The change in the IMFT investment account was an increase of $656 million. Because IMFT is a research venture, it is currently incurring costs. Intel’s share of these costs is $415 million. Thus, in order for this negative income activity to reconcile with a $656 million increase in the investment account, it suggests that Intel made a capital contribution of $1,071 million (i.e., $656 million + $415 million). b. Intel owns 49% of IMFT. If Intel’s share of the costs is $415 million, then the total costs incurred by IMFT is $847 million (i.e., $415 million / 49%).
29.
a. Based solely on the book value of net assets of the investees, the equity method balance is equal to 24.9% x $20,171 million = $5,023 million. b. Based solely on the reported net income of the investees, the equity method income is equal to 24.9% x $1,800 million = $448 million. c. The ownership percentage changed from 23.2% to 24.9%. It's likely ADM made incremental investments in unconsolidated affiliates that is greater than the amount of dividends received from these affiliates.
30.
a. The balance of the Equity Investment in Pop decreased by $1.9 million (i.e., $96.8 million - $98.7 million) during the year ended March 31, 2017. The things that change Equity Investment are an investee’s reported income and dividends, capital contributions to the investee and/or disposal of ownership in the investee. According to Lionsgate’s disclosure, its share of Pop’s net losses equals $6.9 million. In addition, Lionsgate contributed $5.0 million to Pop. These two items reconcile to the $1.9 million decrease in the account, so there was no other activity in the account, including dividends. Thus, the amount of dividends declared and paid by Pop equals $0. b. If dividends for the year ended March 31, 2017 equals $0, then the change in the Equity investment account will be comprised of Lionsgate’s share of the net loss of Pop and Lionsgate’s capital contributions to Pop. The March 31, 2016 balance equals $98.7 million. After backing out the $8.8 million capital contribution and the $1.8 million share of Pop’s net loss, the March 31, 2015 balance equals $91.7 million.
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Advanced Accounting, 4th Edition
31. Equity investment
145,000
Cash (to record the purchase of the Equity investment) Equity investment
145,000
25,000
Equity income (to record equity income) Cash
25,000
20,000
Equity investment (to record receipt of the cash dividend) Equity income
20,000
2,000
Equity investment (to record the amortization of the patent asset) Cash Equity investment* Gain on sale (to record the sale of the Equity investment)
2,000
180,000 148,000 32,000
*The Equity Investment balance on the date of sale is ($145,000 + $25,000 - $20,000 - $2,000 = $148,000)
Solutions Manual, Chapter 1
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32.
a. If an investor holds an equity interest that does not convey control or significant influence over and investee, then the investor is required to use the fair value method to account for the Equity Investment if the investment securities have a readily determinable fair value. Upon acquiring an additional equity stake in the investee that increases the level of ownership to significant influence over the investee, then the investor must begin using the equity method to account for the Equity Investment. However, immediately before accounting for the investment under the equity method, the investor must mark the preexisting equity holding to fair value. Based on the March 1, 2019 transaction, the implied fair value of the entire investee entity is $4,500,000 (i.e., $765,000 / 17%). This suggests the original 8% investment has a fair value of $360,000, and the investor should recognize a $20,000 (i.e., $360,000 - $340,000) holding gain to write up the securities. Here are the journal entries for the facts in the problem: Equity investment 20,000 Unrealized holding gain (to mark the preexisting holding of equity securities to fair value.)
20,000
Equity investment Cash (to record the acquisition of additional equity securities)
765,000
765,000
b. If the equity securities did not have a readily determinable fair value, then the investor would have used a cost-based approach to account for the securities. Absent an other-than-temporary impairment, the Equity Investment account would have remained at the original cost up until the purchase of additional securities. If the transaction to purchase the additional interest is considered an observable price change in orderly transaction, then the original investment would have been marked up to fair value on the date the additional securities are obtained. In this case the amount of gain/loss that needs to be recognized is based on the implied fair value of the original 8% investment. Based on the March 1, 2019 transaction, the implied fair value of the entire investee entity is $4,500,000 (i.e., $765,000 / 17%). This suggests the original 8% investment has a fair value of $360,000, and the investor should recognize a $40,000 holding gain (i.e., $360,000 - $320,000) to write up the securities. Here are the journal entries for the facts in the problem: Equity investment 40,000 Unrealized holding gain (to mark the preexisting holding of equity securities to fair value.)
40,000
Equity investment Cash (to record the acquisition of additional equity securities)
765,000
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765,000
Advanced Accounting, 4th Edition
35.
The percentage disclosures suggest that most of the ventures are 50% owned. We can also try to infer the ownership percentages based on the disclosed financial data. And, the Equity Investment is 58% ($1,156 / $1,991) of the Stockholders’ Equity of the investee companies. Of course, as a practical matter, the actual percentage ownership is likely closer to just below 50%. Because the investees are not consolidated, then we know Cummins does not control them. The summarized balance sheet information is based on the investee’s historical-cost-based accounting records. Equity Investments are usually purchased for a premium over the investee’s book value and this premium is either amortized (e.g., based on depreciable assets) or remains in the account (e.g., based on non-depreciable assets, like land, or indefinitely lived intangible assets, like goodwill). (As an aside, this is typically the amount of information that companies provide in their Equity Investments footnotes).
36.
a. Based on the balance sheet, the average ownership interest of equity method affiliates is 29% (¥2,845,422 million / ¥9,955,614 million) b. Based on the income statement, the average ownership interest of equity method affiliates is 33% (¥362,060 million / ¥1,099,080 million) c. There are three primary reasons the balance-sheet-based and income-statementbased inferred ownership amounts won’t equal. First, the computations are based on aggregate financial statement information across 54 different equity method affiliates. The relative amounts recognized across these companies income statements and balance sheets will be proportionally different. In addition, the financial statement data presented for the affiliated companies is based on reported (historical-cost-based) amounts. The equity investment accounts will often include premiums to these reported amounts that are not included in the affiliates’ reported book values. In addition, the equity method information will include deferral of profits to the periods in which they are recognized via transactions with unaffiliated parties. d. Beginning balance (3/31/2016) Equity income Dividends Plug Ending balance (3/31/2017)
2,631,389 362,060 (180,326) 32,299 2,845,422
The ¥32,299 reconciling item is a net investment in the affiliates. Given that there are the same number of affiliates on March 31, 2016 and 2017, this is likely not the purchase of a new affiliate. Instead, it appears to be the purchase of an additional ownership stake in an existing investment, or a capital contribution.
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Advanced Accounting, 4th Edition
37.
a. The displayed amount of deferred licensing income is only for Lionsgate’s 31.15% interest in EPIX. The 100% amount of 2017 deferred profit is $39.81 million (i.e., $12.4 million / 31.15%) and the 100% amount of recognized (i.e., previously deferred) profit is $22.47 million (i.e., $7.0 million / 31.15%). Thus the total EPIX income without the deferred or recognized (i.e., previously deferred) profit is $99.36 million (i.e., $116.7 million - $39.81 million + $22.47 million) b. The eliminations of licensing profits (12.4, 7.3, 10.2) has a higher variance than the subsequent realizations (7.0, 7.7, 7.6). This pattern implies that the life of the licenses is longer than the next fiscal year. (If each license was no more than a year in length, then the full amount of the eliminated profit would be realized in the following year.) The fact that the licenses are multi-year and that they are recorded in EPIX’s inventory means that the realization of licenses will be much smoother than the initial sale activity. This is much the same way that capitalization and depreciation of fixed assets smooths out the higher variance capital expenditures cycles at companies.
38.
a. General Mills accounts for the investments in its joint ventures using the equity method. Consolidation is not appropriate because General Mills does not control these entities (General Mills does not have >50% equity interest). Also, the fair value method is inappropriate because General Mills is able to exert “significant influence” in the management of these businesses (Companies may take an irrevocable option to value each individual equity investment at fair value under ASC 825-10-25.). Under the equity method, these investments are reflected on General Mills’ balance sheet at adjusted cost (i.e., beginning balance plus proportionate share of investee company’s earnings less any dividends received). General Mills reports its proportionate share of investee company earnings as income. Under the equity method of accounting, dividends are not income. Instead, they are treated as a return of the investment. b. The $505.3 million investment balance on General Mills’ balance sheet represents the net equity of its joint ventures. General Mills’ proportionate share of the assets of the joint ventures, as well as its proportionate share of the joint ventures’ liabilities, is not reflected on its balance sheet, only the net equity. As a result, General Mills’ balance sheet does not reflect the actual investment and liabilities required to conduct these operations. For example, the total joint venture assets of $1,708.6 million less the investment balance of $505.3 million equal $1,203.3 million and these are not recorded on General Mills’ balance sheet. Similarly, the liabilities of $1,524.8 million are also excluded. This is the primary criticism of equity method accounting.
Solutions Manual, Chapter 1
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c. Although General Mills may not have legal liability for the obligations of its joint ventures, it might have an implicit obligation to stand behind the entities that it has created (which includes their financing). That is, General Mills would be hardpressed to walk away from one of these entities should it fail to pay its debts. d. Equity method accounting presents at least two challenges for analysis purposes. (i) Equity method accounting obscures the actual assets and liabilities of the investee company on the books of the investor company. (ii) The equity investments are reported at adjusted cost. As a result, unrealized gains (say, from fair value appreciation) are not reflected on the balance sheet or in the income statement.
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Advanced Accounting, 4th Edition
Advanced Accounting Fourth Edition By Patrick E. Hopkins and Robert F. Halsey
Solution Manual Chapter 2— Introduction to Business Combinations and the Consolidation Process 1.
The Scope section of FASB ASC 805-10-15 specifically excludes joint ventures from the provisions of the standard. As a result, joint ventures are not required to be consolidated and should be accounted for using the equity method.
2.
FASB ASC 805-10-65-1: “The acquirer’s application of the recognition principle and conditions may result in recognizing some assets and liabilities that the acquiree had not previously recognized as assets and liabilities in its financial statements. For example, the acquirer recognizes the acquired identifiable intangible assets, such as a brand name, a patent, or a customer relationship, that the acquiree did not recognize as assets in its financial statements because it developed them internally and charged the related costs to expense.”
3.
FASB ASC 805-30-30-8 provides the following guidance relating to the transfer of assets other than cash and stock: “The consideration transferred may include assets or liabilities of the acquirer that have carrying amounts that differ from their fair values at the acquisition date (for example, nonmonetary assets or a business of the acquirer). If so, the acquirer shall remeasure the transferred assets or liabilities to their fair values as of the acquisition date and recognize the resulting gains or losses, if any, in earnings. However, sometimes the transferred assets or liabilities remain within the combined entity after the business combination (for example, because the assets or liabilities were transferred to the acquiree rather than to its former owners), and the acquirer therefore retains control of them. In that situation, the acquirer shall measure those assets and liabilities at their carrying amounts immediately before the acquisition date and shall not recognize a gain or loss in earnings on assets or liabilities it controls both before and after the business combination.” Bottom line – if the asset will not remain with the consolidated group following the acquisition, the acquirer can write up the asset before transfer and record the resulting gain in income. And, if the asset remains with the consolidated entity post-acquisition, it cannot be written up and no gain is recognized.
Solutions Manual, Chapter 2
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4.
FASB ASC 805-20-25-12 allows the acquirer to determine if the operating leases are “favorable or unfavorable” compared with the market terms of similar leases at the acquisition date. The acquirer shall recognize an intangible asset if the terms of an operating lease are favorable relative to market terms and a liability if the terms are unfavorable relative to market terms. FASB ASC 805-20-25-13 also provides for the recognition of an intangible asset relating to operating leases, even if their terms are not deemed to be favorable, if the leases provide entry into a market or other future economic benefits that qualify as identifiable intangible assets, for example, as a customer relationship.
5.
FASB ASC 805-20-55-6 provides the following guidance: “The acquirer subsumes into goodwill the value of an acquired intangible asset that is not identifiable as of the acquisition date. For example, an acquirer may attribute value to the existence of an assembled workforce, which is an existing collection of employees that permits the acquirer to continue to operate an acquired business from the acquisition date. An assembled workforce does not represent the intellectual capital of the skilled workforce―the (often specialized) knowledge and experience that employees of an acquiree bring to their jobs. Because the assembled workforce is not an identifiable asset to be recognized separately from goodwill, any value attributed to it is subsumed into goodwill.”
6.
FASB ASC 805-20-55-7 provides the following guidance: “The acquirer also subsumes into goodwill any value attributed to items that do not qualify as assets at the acquisition date. For example, the acquirer might attribute value to potential contracts the acquiree is negotiating with prospective new customers at the acquisition date. Because those potential contracts are not themselves assets at the acquisition date, the acquirer does not recognize them separately from goodwill. ”
7.
FASB ASC 805-20-55-25 provides the following guidance: The agreement, whether cancelable or not, meets the contractual-legal criterion. Additionally, because the Subsidiary establishes its relationship with Customer through a contract, not only the agreement itself but also the subsidiary’s relationship with the Customer meets the contractual-legal criterion.
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8.
FASB ASC 805-20-55-22 provides the following guidance: “An order or production backlog arises from contracts such as purchase or sales orders. An order or production backlog acquired in a business combination meets the contractual-legal criterion even if the purchase or sales orders are cancelable.” Regardless of whether or not they are cancelable, the purchase orders from 60 percent of the Subsidiary’s customers meet the contractual-legal criterion. Additionally, because the Subsidiary has established its relationship with 60 percent of its customers through contracts, not only the purchase orders but also the Subsidiary’s customer relationships meet the contractual-legal criterion. Because the subsidiary has a practice of establishing contracts with the remaining 40 percent of its customers, its relationship with those customers also arises through contractual rights and therefore meets the contractual-legal criterion even though the Subsidiary does not have contracts with those customers as of the acquisition date.
9.
FASB ASC 805-20-55-23 provides the following guidance: “If an entity establishes relationships with its customers through contracts, those customer relationships arise from contractual rights. Therefore, customer contracts and the related customer relationships acquired in a business combination meet the contractual-legal criterion….” Because the Subsidiary establishes its relationships with policyholders through insurance contracts, the customer relationship with policyholders meets the contractual-legal criterion, and can be identified as an intangible asset in the acquisition.
10.
FASB ASC 805-10-55-35 provides the following guidance (the acquired company is referenced as the “Target”): “In this Example, Target entered into the employment agreement before the negotiations of the combination began, and the purpose of the agreement was to obtain the services of the chief executive officer. Thus, there is no evidence that the agreement was arranged primarily to provide benefits to Acquirer or the combined entity. Therefore, the liability to pay $5 million is included in the application of the acquisition method.”
11.
FASB ASC 805-10-55-36 provides the following guidance (the acquired company is referenced as the “Target”): “In other circumstances, Target might enter into a similar agreement with the chief executive officer at the suggestion of Acquirer during the negotiations for the business combination. If so, the primary purpose of the agreement might be to provide severance pay to the chief executive officer, and the agreement may primarily benefit Acquirer or the combined entity rather than Target or its former owners. In that situation, Acquirer accounts for the liability to pay the chief executive officer in its post-combination financial statements separately from application of the acquisition method.”
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12.
Yes, the investor has gained effective control of the investee company by virtue of its control of the Board of Directors. Even though it owns less than 50% of the outstanding voting stock, the license agreement gives it control of the investee company and, as a result, the investee must be consolidated with the investor.
13.
The acquisition should be accounted for as a business combination, thus requiring consolidation. It is not necessary for the business to have outputs (i.e., products and sales). FASB ASC 805-10-55-4 defines a business as follows: “A business consists of inputs and processes applied to those inputs that have the ability to create outputs. Although businesses usually have outputs, outputs are not required for an integrated set to qualify as a business.”
14.
a. Assets and liabilities can be valued using any reasonable approach. Some common approaches to the tangible assets and liabilities in this example include the following: Accounts receivable:
Net realizable value (the amount we expect to collect)
Inventories:
Estimated selling price less cost to complete (if work-inprocess) and less selling costs and a reasonable profit margin on the sale. Raw materials are valued at replacement cost.
PPE:
Current replacement costs if continued to be used in the business or at selling price less cost to sell if to be sold.
Current liabilities:
Book value
Long-term liabilities:
Present value (i.e., discounted expected cash outflows)
b. Before any portion of the purchase price can be allocated to the Goodwill asset, you must first ask if you are acquiring any intangible assets that are not recorded on the acquiree’s balance sheet. A complete listing is in Exhibit 2.12. FASB ASC 805 requires us to make a positive assessment whether any of these intangible assets were valued by us in arriving at our purchase price for the acquiree and, if so, we must assign that value to the intangible assets acquired before any of the purchase price can be assigned to the Goodwill asset. c. Intangible assets are typically valued at the present value of expected future cash flows. We must, first, project the cash flows to be derived from the intangible asset. Then, we need to discount those expected cash flows using an appropriate discount rate. This is a very subjective process, as both the estimate of future cash flows and the choice of the appropriate discount rate are difficult. We must make a reasonable attempt, however, to value these intangible assets using a reasonable and supportable methodology. ©Cambridge Business Publishers, 2020 2-4
Advanced Accounting, 4th Edition
15. Intangible Asset Category
16.
Examples
Contract-based:
Lease agreements, franchise agreements, licensing agreements, construction contracts, employment contracts, and mineral rights
Marketing-related:
Brand names, trademarks, and Internet domain names
Customer-related:
Customer contracts, relationships, and orders
Technology-based:
Patent rights, computer software, and trade secrets
Artistic-related:
Television programs, motion pictures and videos, recordings, books, photographs, and advertising jingles
An indemnification asset represents the agreement by the seller to guarantee that the acquirer will not suffer a loss as a result of the outcome of a contingency related to all or part of a specific asset or liability. For example, the seller may indemnify the purchaser against losses above a specified amount on a liability arising from a particular contingency, such as a pending lawsuit. The acquirer recognizes an indemnification asset at the same time that it recognizes the indemnified item (the contingent liability, for example). In addition, both the indemnification asset and the related liability are revalued subsequent to the acquisition (FASB ASC 805-20-25-27 through 25-28 and FASB ASC 805-20-35-4).
17.
FAASB ASC 805-20-55-20 identifies a number of customer-related intangible assets, including the following: a. Customer lists—a customer list acquired in a business combination normally meets the separability criterion. b. Order backlog—an order or production backlog acquired in a business combination meets the contractual-legal criterion even if the purchase or sales orders are cancelable. c. Customer relationship—If an entity has relationships with its customers through sales orders, they meet the contractual-legal criterion. Customer relationships also may arise through means other than contracts, such as through regular contact by sales or service representatives.
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18.
a. Restructuring plans typically include the termination of employees as departments are merged, the divestiture of lines of businesses with related plant closing costs, the relocation and training of employees, and the write-off of assets such as Goodwill on the acquiree’s balance sheet that relate to previous acquisitions that will no longer play a part in the consolidated company. b. FASB ASC 805-20-25-2 provides the following guidance relating to planned restructuring activities: “To qualify for recognition as part of applying the acquisition method, the identifiable assets acquired and liabilities assumed must meet the definitions of assets and liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements, at the acquisition date. For example, costs the acquirer expects but is not obligated to incur in the future to effect its plan to exit an activity of an acquiree or to terminate the employment of or relocate an acquiree’s employees are not liabilities at the acquisition date. Therefore, the acquirer does not recognize those costs as part of applying the acquisition method. Instead, the acquirer recognizes those costs in its post-combination financial statements in accordance with other applicable generally accepted accounting principles (GAAP).”
19.
If financial statements are issued before the final allocations of the purchase can be made, FASB ASC 805-10-55-16 allows us to use “provisional amounts,” that is, estimates of those values. When the allocation adjustments are made, we prospectively adjust those amounts, provided that the final measurement of all assets and liabilities is completed within one year from the acquisition date. Also, during the measurement period, the acquirer can recognize additional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets and liabilities as of that date.
20. A
a. No, a contingent liability for the employee litigation is not recognized at fair value on the acquisition date because your attorney has determined that an unfavorable outcome is reasonably possible, but not probable (ASC 450-20-25-2). Therefore, your company would recognize a liability in the post-combination period when the recognition and measurement criteria in ASC 450 are met. b. The indemnification by the acquiree becomes an “indemnification asset” for the purchaser and can be recognized as such on the consolidated balance sheet at the same amount. Net assets acquired are, therefore, unaffected. Until the lawsuit is settled or finally adjudicated, the contingent liability and the indemnification asset must both be revalued at each balance sheet date and the change in value reflected in income (see question 16). Since the asset and liability are offsetting, however, their revaluation will have offsetting amounts in the income statement, leaving net income unaffected.
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Advanced Accounting, 4th Edition
21. A
a. Equity investment Common Stock APIC Contingent earnings liability
17,500,000 800,000 15,200,000 1,500,000
(to record the acquisition)
b. Expense related to contingent earnings liability Contingent earnings liability
600,000 600,000
(to record the increase in the expected value of the contingent earnings liability)
c. Expense related to contingent earnings liability Contingent earnings liability Cash
1,900,000 2,100,000 4,000,000
(to record payment of the contingent earnings liability)
22. B Purchase price Less: Fair value of assets acquired Deferred tax liability Goodwill 23.
$5,000,000 4,800,000 (168,000)
4,632,000 $368,000
($800,000 x 21%)
According to paragraph 14 of the 1979 AICPA Issues Paper, proponents of pushdown accounting view the change in control transaction as essentially the same as if the new owners had purchased the net assets of an existing business and established a new entity to continue that business. They believe that reporting on a new basis in the separate financial statements of the continuing entity would provide information that is more relevant to financial statement users. The change in control transaction is the same as if the new owners purchased the net assets of an existing business and established a new entity to continue the business. Opponents of pushdown accounting believe that a change in ownership of an entity does not establish a new accounting basis in its financial statements under the historical cost accounting framework. Since the reporting entity did not acquire assets or assume liabilities as a result of the transaction, the recognition of a new accounting basis based on a change in ownership, rather than on a transaction on the part of the entity, is undesirable under a ”historical cost framework.” (Of course, financial accounting principles reflect a mixed-attribute measurement model, so any justification based on a historical cost justification would need to describe how that information basis provides superior information to users of financial statements.) Opponents of pushdown accounting also note that a new basis of continued
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accounting would be detrimental to interests of holders of existing debt and non-voting capital stock who depend on comparable financial statements for information about their investments and do not have access to other financial information. Push down accounting would affect the ability of the entity to comply with debt covenants required by outstanding debt and would materially alter the relationships in the entity's financial statements. 24.
Answer: b In a (basket) net asset acquisition that does not constitute a business, as that term is defined in FASB ASC 805 (“Business Combinations”), the total consideration paid for the net assets is allocated to the individual net asset accounts on the basis of proportional fair value, as follows:
Production equipment Factory Licenses Total
25.
Fair Value 500 800 700 2,000
%FV 25% 40% 35% 100%
Allocated 515.0 824.0 721.0 2,060.0
Answer: a Goodwill is only recorded when the acquired net assets (or legal entity) constitutes a business, as that term is defined in FASB ASC 805 (“Business Combinations”).
26.
Answer: c When acquired net assets (or a legal entity) constitute a business, as that term is defined in FASB ASC 805 (“Business Combinations”), the individual identifiable acquired net assets are reported at fair value on the acquisition date.
27.
Answer: d When acquired net assets (or a legal entity) constitute a business, as that term is defined in FASB ASC 805 (“Business Combinations”), the amount of recognized goodwill is equal to the fair value of the entire acquired business (i.e., $2,180 consideration transferred) less the fair value of the identifiable net assets (i.e., $2,000, see above solution to #11). This results in $180 of goodwill recognized on the acquisition date.
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28.
Answer: d Given that fair value of net assets approximates the book value of net assets and there is no goodwill recognized, this means that the book value of net assets of the subsidiary approximates the overall value of the consideration transferred for the company (i.e., $280,000). Given that the parent company transferred 10,000 shares, this means that the per share value for the parent company stock is $28/share (i.e., $280,000/10,000).
29.
Answer: b Given that fair value of net assets approximates the book value of net assets and there is no goodwill recognized, this means that the book value of net assets of the subsidiary approximates the overall value of the consideration transferred for the company (i.e., $280,000). This means that the investment account equals $280,000 on the acquisition date.
30.
Answer: b Goodwill is equal to the difference between the value of the acquired entity as a whole minus the fair value of the acquiree’s individual net assets. In this case, the fair value of the acquiree entity is the value of the stock transferred as consideration (i.e., $27 x 22,500 shares = $607,500). The fair value of the individual net assets is $424,200, which means the goodwill is $183,300 (i.e., $607,500 – 424,200).
31.
Answer: d The amount recorded for the investment account is the value of the consideration transferred in exchange for the investee’s common stock (i.e., $27 x 22,500 shares = $607,500).
32.
Answer: c A business is “An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants.” It is not necessary that the investee company currently produce products or generate a positive return. All that is necessary is that it a. has begun planned principal activities, b. has employees, intellectual property, and other inputs and processes that could be applied to those inputs, c. is pursuing a plan to produce outputs, and d. will be able to obtain access to customers that will purchase the outputs.
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33.
Answer: a Company A has a controlling financial interest in both Companies B (85%) and C (85% x 65% = 55.25%). Therefore B and C should be consolidated with A.
34.
Answer: b By holding 14,560 shares, former company B shareholders will own 56% (i.e., 14,560 / (11,440 + 14,560) of the common stock after the transaction, suggesting they control the company and can elect controlling Board within the next two years.
35.
Answer: c Direct fees have no effect on recording the business combination; these costs are simply expensed as part of operating expenses for the period in which they are incurred. The entry is as follows: Expenses
200,000 Payables or cash (for direct acquisition costs)
200,000
Costs of registering and issuing securities are deducted from contributed capital; thus, they have no effect on the investment account. The fair value of the common stock that is issued (i.e., $8,000,000 = 800,000 shares x $10.00/share) will equal the amount of the net assets that will be recognized in a business combination. The entry is as follows: Investment in Investee Common Stock ($1 par) APIC Payables or cash (for registration costs) 36.
8,000,000 800,000 7,100,000 100,000
Answer: a A controlling investment in an investee company’s common stock is accounted for in an equity investment account on the pre-consolidation books of the investor company. Thus, there is no separate pre-consolidation recognition of goodwill. The process of consolidation will eliminate the investment account and replace it with the fair value of the net assets of the subsidiary in the post-consolidation financial statements.
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Advanced Accounting, 4th Edition
37.
Answer: b The amount of goodwill implicit in an acquisition-date controlling investment in a subsidiary is equal to the fair value of the entire subsidiary (i.e., $1,000,000) minus the fair value of the identifiable net assets (FVINA). According to the facts, the book value of the identifiable net assets is equal to $700,000. The only identifiable difference between fair value and book value is $250,000 related to property and equipment. Thus, the FVINA is equal to $950,000 (i.e., $700,000 + $250,000). Therefore, goodwill is equal to $50,000 (i.e., $1,000,000 - $950,000).
38.
Answer: a In the case where (1) the fair value of the identifiable net assets of a subsidiary equals the book value of identifiable net assets of the subsidiary, and there is no recorded goodwill or bargain acquisition gain, then the investment account will equal the book value of net assets of the subsidiary (i.e., which also equals the stockholders’ equity of the subsidiary). Net assets equals $180,000 (i.e., CS, $20,000 + APIC, $140,000 + RE, $20,000).
39.
Answer: b In the absence of profits (losses) on intercompany transactions, the investment account at any point in time can be computed by taking p% of the book value of net assets (BVNA) of the subsidiary and adding the unamortized p% acquisition accounting premium (AAP). In this problem, p% = 100%. On the acquisition date, the unamortized AAP is equal to the following (note that the amounts are expressed in debits and credits):
Receivables & Inventories Land Property & Equipment Goodwill Liabilities Total AAP
AAP Dr (Cr) 10,000 (5,000) 20,000 25,000 7,000 57,000
100% BVNA(S) + 100% AAP = $180,000 + $57,000 = $237,000 40.
Answer: d Consolidated financial statements must be prepared by a company that has a “controlling financial interest” in other entities. In this case, Sun also prepares standalone financial statements (perhaps for a bank or other creditor). There is no evidence that Sun has a controlling financial interest in another entity.
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41.
Answer: d Assuming no intercompany payables/receivables, on the acquisition date, there are only two consolidating journal entries required: [E] and [A]. The [E] entry eliminates the book value of net assets of the subsidiary (i.e., which equals reported stockholders’ equity) from the investment account. Stockholders’ equity of the investee equals $550,000 (i.e., CS $120,000 + APIC $150,000 + RE $280,000). This means the [A] credit to the investment account must have been $320,000 (i.e., $870,000 - $550,000).
42. B
Answer: c Generally speaking, in a nontaxable transaction, the pre-acquisition tax bases of the subsidiary’s net assets carry forward to the post-acquisition tax books. This can result in deferred taxes if the recognized fair values have temporary differences from the carried forward tax bases. In this case, the only asset that has a different tax basis from its newly recognized fair value is noncurrent assets with a fair value that is $30,000 greater than its previous book value and tax basis. The deferred tax liability on this $30,000 temporary difference is $6,000 (i.e., 20% x $30,000). Therefore, including the deferred tax, the fair value of the identifiable net assets (FVINA) for the subsidiary is equal to $104,000 (i.e., BVINA $80,000 + noncurrent asset AAP $30,000 – deferred tax liability AAP $6,000). Goodwill is equal to the fair value of the entire subsidiary minus the FVINA, which equals $56,000 (i.e., FV subsidiary $160,000 – FVINA $104,000).
43. B
Answer: d Generally speaking, in a taxable transaction, the post-acquisition tax bases of the subsidiary’s net assets are equal to the fair value of the net assets of the subsidiary. Given no difference in financial versus tax bases, this means that there are no deferred taxes recognized pursuant to the acquisition. In this problem, the only asset that has a different tax basis from its newly recognized fair value is noncurrent assets with a fair value that is $30,000 greater than its previous book value and tax basis. Therefore, the fair value of the identifiable net assets (FVINA) for the subsidiary is equal to $110,000 (i.e., BVINA $80,000 + noncurrent asset AAP $30,000). Goodwill is equal to the fair value of the entire subsidiary minus the FVINA, which equals $50,000 (i.e., FV subsidiary $160,000 – FVINA $110,000).
44.
Answer: b After a change of control event, the acquiree has the option to apply pushdown accounting in its separate pre-consolidation financial statements. This election is irrevocable and has no impact on the requirement that the parent company prepare consolidation financial statements that incorporate all entities the parent controls. The pushdown process results in the subsidiary recording the effects of the AAP on its preconsolidation books. This will result in a subsidiary’s pre-consolidation individual net assets being reported at fair value, consistent with FASB ASC 805.
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45.
a. The cost is allocated to the acquired net assets based on relative fair values:
Production equipment Factory Land Patents
Book Value 300 1,500 100 1,900
Fair Value 240 1,200 600 360 2,400
%FV 10.0% 50.0% 25.0% 15.0% 100.0%
Allocated Cost 230 1,150 575 345 2,300
This results in the following journal entry: Production equipment Factory Land Patents
230 1,150 575 345
Cash (to record purchase of the assets and assumption of the liabilities that does not qualify as a business)
2,300
b. Production equipment Factory Land Patents Goodwill Expenses (transaction costs)
240 1,200 600 360 50 50
Cash Contingent consideration liability (to record purchase of the assets and assumption of the liabilities that qualifies as a business)
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2,300 200
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46.
a. Cash Accounts receivable Inventories PPE, net
1,680 3,360 6,720 16,800
Accounts payable Accrued liabilities Long-term liabilities Cash (to record purchase of the assets and assumption of the liabilities that constitute a business)
3,360 5,040 6,720 13,440
b. Equity investment
13,440
Cash (to record the acquisition of the investee’s common stock) 47.
13,440
a. Cash Accounts receivable Inventories PPE, net Customer List
1,680 3,360 6,720 23,520 5,040
Accounts payable Accrued liabilities Long-term liabilities Cash (to record purchase of the assets and assumption of the liabilities of a business)
3,360 5,040 6,720 25,200
b. Equity investment Cash (to record purchase of the assets and assumption of the liabilities of a business)
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48.
In both parts of this problem, the value of the common stock issued by the investor company is the same: $399,000 (i.e., 11,400 shares x $35/share). On the investor’s books, this is split between “Common stock ($1 par)” for $11,400 and “Additional paidin capital” for $387,600. The difference between parts a and b is whether (a) the investor recognizes the investee’s individual net assets at fair value or (b) an investment account. When the investor recognizes the individual net assets in part a, it will also recognize goodwill implicit in the acquisition. The goodwill is equal to $27,000 (i.e., FV of investee, $399,000 – FV of the identifiable net asset of the investee, $372,000). In part b, we only recognize the investment account in the pre-consolidation financial statements of the acquirer; thus, the goodwill is inside the investment account and only becomes part of the investor’s financial statements after consolidation. a. The journal entry to record the acquisition of the net assets follows: Receivables & Inventories Land Property & Equipment Trademarks & Patents Goodwill Liabilities Common Stock ($1 par) APIC
54,000 180,000 156,000 96,000 27,000 114,000 11,400 387,600
The effects of this entry are reflected in the FV Investee column in the following worksheet: (BV)
(FV)
Dr. (Cr) Receivables & Inventories Land Property & Equipment Trademarks & Patents Investment in Investee Goodwill Total Assets
Investor
Investee
Post-Acqu.
$ 120,000 240,000 270,000
$ 54,000 180,000 156,000 96,000
$ 630,000
27,000 $ 513,000
$ 174,000 420,000 426,000 96,000 0 27,000 $ 1,143,000
Liabilities Common Stock ($1 par) APIC Retained Earnings Total Liabilities & Equity
$180,000 24,000 336,000 90,000 $630,000
$114,000 11,400 387,600 $ 513,000
$ 294,000 35,400 723,600 90,000 $ 1,143,000
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b. The journal entry to record the acquisition of the common stock of the investee follows: Investment in Investee Common Stock ($1 par) APIC
Dr. (Cr) Receivables & Inventories Land Property & Equipment Trademarks & Patents Investment in Investee Goodwill
399,000 11,400 387,600 (BV) Investor
Post-Acqu.*
$120,000 240,000 270,000
$ 399,000 $ 630,000
Liabilities Common Stock ($1 par) APIC Retained Earnings Total Liabilities & Equity
(FV) Investee
$180,000 24,000 336,000 90,000 $630,000
399,000 11,400 387,600 $ 399,000
$ 120,000 240,000 270,000 0 399,000 0 $ 1,029,000 $ 180,000 35,400 723,600 90,000 $ 1,029,000
* = Pre-consolidation
49. Purchase price Fair value of tangible & intangible assets acquired Fair value of liabilities assumed Goodwill 50.
$ 103,136 $ 61,896 (31,165)
30,731 $ 72,405
a. Goodwill = $20 million - $7 million - $4 million - $5 million = $4 million. The acquisition costs are expensed under GAAP (FASB ASC 805-10-25-23). b. Goodwill is not amortized like other intangible assets. Instead, it remains on the balance sheet until management deems it to be impaired, at which time it is written down. c. Allocating more of the purchase price to goodwill reduces the allocation to assets that are depreciated or amortized and, therefore, reduces the depreciation and/or amortization expense hitting their income statements subsequent to the acquisition.
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51.
a. The amounts relating to working capital, inventories and PPE assets are the fair values of those assets on the acquisition date. These amounts reflect the book values of those assets on DuPont’s balance sheet plus the AAP, the difference between fair value and book value. These are the amounts that will appear on the consolidated balance sheet relating to DuPont, and the reported amounts will be the sum of these values plus the book value of these assets on Dow’s balance sheet on the acquisition date. b. In-process research and development (IPRD) assets relate to the acquisition-date value of research projects currently in process and during their developmental stages (i.e., before the research projects have reached technological feasibility). Under current GAAP, investors value and recognize IPRD assets acquired in a business combination at their fair values just like any other assets acquired (FASB ASC 350-30-30-1). After initial recognition, tangible net assets used to support research and development activities (e.g., R&D building and associated equipment) are accounted for in accordance with their nature (i.e., they are depreciated/amortized). Intangible research and development assets, on the other hand, should be considered indefinite-lived (i.e., not amortized) until the associated research and development activities are either completed (then, the intangible assets are amortized over the life of the related patent or copyright) or abandoned (in which case they are written off in the year of abandonment). Acquired intangible IPRD assets are included in the annual goodwill impairment tests (FASB ASC 350-2035-15). c. The value assigned to Goodwill is not computed directly. Instead, it is computed as a residual amount (i.e., the amount left over after all other assets and liabilities have been identified and valued). d. Because of the complexity inherent in business combinations, it is not uncommon for the accounting to take some time to complete. FASB ASC 805-10-25-13 through 25-19 permits companies to use “provisional” amounts, and to retrospectively adjust those amounts when better information becomes available, provided that the final measurement of all assets and liabilities is completed within one year from the acquisition date. Also, during the measurement period, the investor can recognize additional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets and liabilities as of that date. The adjustments are recognized prospectively (i.e., not retroactively), with the incremental adjustment fully recognized in the period in which the measurement was changed. Therefore, if the measurements were revised during the quarter ended December 31, 2017, the adjustment will be fully reflected in DowDuPont’s quarterly financial statements for the three months ended December 31, 2017.
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52.
a. The arguments in favor of Company A as the acquirer are the following: i.
It issued the stock.
ii. Its CEO will become CEO of the combined company. The arguments in favor of Company B as the acquirer are the following: i.
Its Chairman will become Chairman of the combined company.
ii. Its CFO will become CFO of the combined company. On balance, it would appear that Company A is the acquirer. Its CEO will be the chief executive of the combined entity, and, in three years, Company A’s Chairman will become the new Company Chairman as well. During the interim, neither company can control the strategic direction of the combined company since each elects onehalf of the Board of Directors. b. The allocation of the purchase price is quite different for the two potential acquirers:
Purchase Price Identifiable tangible net assets Identifiable intangible assets Goodwill
If Company A is deemed to be the Accounting Acquirer $ 12.0 billion (2.5 billion) (5.0 billion) $ 4.5 billion
If Company B is deemed to be the Accounting Acquirer $ 12.0 billion (6.0 billion) (3.0 billion) $ 3.0 billion
If Company B is the accounting acquirer and Company A is the subsidiary, more of the purchase price will be allocated to the fair value of total identifiable tangible and intangible net assets (i.e., $9.0 billion). Both of these categories are usually depreciated or amortized (e.g., except for land and some indefinite-lived intangible assets). As a result, more of the purchase cost will likely hit the consolidated income statement (Goodwill is not amortized, and becomes an expense only if impaired). Also, if Company B is the acquirer, less Goodwill asset will be recognized. The determination of an acquirer is often not a difficult issue. But, when it is, it can be a significant one. continued
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Advanced Accounting, 4th Edition
b. continued This analysis is made solely from a financial perspective. There are other significant implications of the choice of the acquirer, including •
The acquirer may get to name the combined company with its name or using its name first.
•
The image of the combined company in the market place may be different depending on which company is viewed as the acquirer.
•
The acquirer’s philosophies and modes of operation may dominate the combined company.
•
The acquirer may get the choice of the home office.
•
The acquirer’s employees may feel a sense of superiority. Conversely, the acquiree’s employees may feel like they’ve been taken over. This can cause real morale problems if not handled well.
53. a. Equity investment Common stock Additional paid-in capital
200,000 40,000 160,000
(to record the acquisition)
b. [E]
Common stock Retained earnings Equity investment
40,000 100,000 140,000
(to eliminate the Stockholders’ Equity of the subsidiary on the acquisition date)
[A]
PPE (net)
60,000 Equity investment
60,000
(to record the [A] assets purchased on the acquisition date)
Solutions Manual, Chapter 2
©Cambridge Business Publishers, 2020 2-19
54.
a. Equity investment Cash
300,000 300,000
(to record the acquisition)
b. [E]
Common stock Retained earnings Equity investment
100,000 60,000 160,000
(to eliminate the Stockholders’ Equity of the subsidiary on the acquisition date)
[A]
Patent Goodwill
120,000 20,000 Equity investment
140,000
(to record the [A] assets purchased on the acquisition date)
55.
a. Balance of Equity Investment account: Purchase price Cumulative net income of subsidiary Cumulative dividends received from subsidiary Balance of Equity Investment account
300,000 250,000 (100,000) 450,000
b. The Equity Investment account is comprised of the amortized acquisition-date fair values of the net assets of the subsidiary ($230,000, which happen to equal the book values) and the carrying amount of the Goodwill asset ($70,000). It doesn’t matter how long management believes goodwill will last; it is not amortized. 56.
a. No, this is the fair value of these assets. The [A] consolidation journal entry records the difference between the fair value and the book value of these assets on the acquiree’s acquisition-date balance sheet. b. [A]
Goodwill Currently marketed products intangible In-process research and development intangible Contract-based arrangements intangible Equity Investment
11,422.4 21,995.0 730.0 42.2 34,189.6
(to record the intangible assets)
©Cambridge Business Publishers, 2020 2-20
Advanced Accounting, 4th Edition
c. The identifiable net asset values reported on June 3, 2016 were based on the best estimates management could identify as of that date. Companies have a period of one year after the acquisition date to reduce the measurement error in those estimates. Despite the fact these measurements are adjusted after the acquisition date, the measurements are supposed to be based on the conditions that existed on the acquisition date. In this case, the largest adjustments decreased inventories, currently marketed products intangible, and in process research and development, with a corresponding adjustment to deferred taxes because of the adjustments in asset values. Because goodwill is simply a residual calculated as the difference between the fair value of consideration transferred and the fair value of identifiable net assets acquired, goodwill is going to change as the overall estimated value of identifiable net assets changes. In this case, goodwill increased by more than $5 billion because the fair value of net assets decreased by more than $5 billion. 57.A
a. •
The fair value of the identifiable intangible asset related to IPR&D was determined using an income approach, through which fair value is estimated based upon the asset’s probability adjusted future net cash flows, which reflects the stage of development of the project and the associated probability of successful completion. The net cash flows were then discounted to present value using a discount rate of 11.5%.
•
The fair value of the contingent consideration was determined utilizing a probability-weighted estimated cash flow stream using an appropriate discount rate dependent on the nature and timing of the milestone payment.
b. The income approach (sometimes referred to as discounted cash flow or DCF approach) involves both the projection of cash flows and the choice of an appropriate discount rate. In its assignment of fair values to the assets acquired and the liabilities assumed in the Afferent acquisition, it appears that the fair values were likely determined using an income approach. This is not uncommon for intangible assets. Remember this next time you look at a fair value assignment table for business combinations. c. The total possible contingent payments for achievement of "clinical development and commercial milestones" related to the Afferent acquisition are $750 million. The acquisition-date fair value of these potential future payments is $223 million. The Afferent transaction includes these contingent (future) payments instead of cash consideration because there was a difference in belief between Merck and the selling shareholders of Afferent about the value of the IPRD. A common way for these negotiation-related disagreements to be settled is to include contingent consideration instead of cash or stock.
Solutions Manual, Chapter 2
©Cambridge Business Publishers, 2020 2-21
d. Contingent consideration liability Loss on acquisition contingency Cash
223 527 750
(to record settlement of acquisition contingency)
58.
a. Goodwill is equal to the difference between the fair value of an acquiree company and the fair value of the acquiree’s identifiable net assets. In this case, the fair value of the acquiree company is $1,200,000 and the fair value of the acquiree’s identifiable net assets is $1,000,000 (i.e., CS of $100,000 + APIC of $200,000 + RE of $300,000 + P&E AAP of $150,000 + Licenses AAP of $250,000). Therefore, goodwill is equal to $200,000. b. Property & Equipment, net 150,000 Licenses 250,000 Goodwill 200,000 Pushdown equity 600,000 (entry required to record the effects of the AAP on the subsidiary’s books) Retained earnings 300,000 Pushdown equity 300,000 (entry required to eliminated retained earnings and establish pushdown-type contributed capital) c. [E] Common stock APIC Pushdown equity Equity investment
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100,000 200,000 900,000 1,200,000
Advanced Accounting, 4th Edition
d. Parent Assets: Cash & receivables Inventory Property & Equipment, net Equity investment Licenses Goodwill Liabilities and stockholders' equity: Current liabilities Other liabilities Note payable Common stock APIC Retained earnings Pushdown equity
Consolidated
800,000 600,000
100,000 200,000
900,000 800,000
2,300,000 1,200,000
925,000
3,225,000 0
4,900,000
275,000 200,000 1,700,000
275,000 200,000 5,400,000
400,000 300,000 1,670,000 1,430,000 1,100,000
150,000 350,000 100,000 [E] 100,000 200,000 [E] 200,000 900,000 [E] 900,000 1,700,000 1,200,000
550,000 300,000 350,000 1,670,000 1,430,000 1,100,000
4,900,000
Solutions Manual, Chapter 2
Subsidiary
Consolidation Entries Dr Cr
[E] 1,200,000
1,200,000
5,400,000
©Cambridge Business Publishers, 2020 2-23
59.
a. 30,000 shares x $20 market price per share = $600,000 b. [E]
Common stock APIC Retained earnings Equity investment
120,000 180,000 300,000 600,000
(to eliminate the stockholders’ equity of the subsidiary on the acquisition date)
c. Parent
Subsidiary
Dr
Cr
Consolidated
Assets Cash
$200,000
$100,000
$300,000
Accounts receivable
300,000
200,000
500,000
Inventory
500,000
400,000
Equity investment
600,000
-
1,000,000
600,000
1,600,000
$2,600,000
$1,300,000
$3,300,000
Accounts payable
$100,000
$100,000
$200,000
Accrued liabilities
200,000
200,000
400,000
Long-term liabilities
800,000
400,000
Common stock
300,000
120,000 [E]
120,000
300,000
APIC
500,000
180,000 [E]
180,000
500,000
Retained earnings
700,000
300,000 [E]
300,000
700,000
PPE, net
900,000 [E]
600,000
0
Liabilities and Equity
$2,600,000
©Cambridge Business Publishers, 2020 2-24
$1,300,000
1,200,000
600,000
600,000
$3,300,000
Advanced Accounting, 4th Edition
60.
a. 80,000 shares x $10 market price per share = $800,000 b. [E]
Common stock APIC Retained earnings Equity investment
100,000 150,000 300,000 550,000
(to eliminate the Stockholders’ Equity of the subsidiary on the acquisition date)
[A]
Patent Goodwill
150,000 100,000 Equity investment
250,000
(to record the [A] assets purchased on the acquisition date)
c. Parent
Subsidiary
$1,000,000 1,200,000 1,600,000 800,000
$160,000 240,000 300,000
Dr
Cr
Consolidated
[E]
550,000
$1,160,000 1,440,000 1,900,000 0
[A]
250,000
Assets: Cash Accounts receivable Inventory Equity investment PPE, net
3,000,000
800,000
$7,600,000 $1,500,000
3,800,000 150,000 100,000 $8,550,000
$600,000 $150,000 1,000,000 200,000 2,000,000 600,000 800,000 100,000 1,400,000 150,000 1,800,000 300,000 $7,600,000 $1,500,000
$750,000 1,200,000 2,600,000 800,000 1,400,000 1,800,000 $8,550,000
Patent
[A]
150,000
Goodwill
[A]
100,000
Liabilities and Equity: Accounts payable Accrued liabilities Long-term liabilities Common stock APIC Retained earnings
[E]
100,000
[E]
150,000
[E]
300,000 800,000
800,000
d. We recognized the Patent and Goodwill assets. Previously, these assets were embedded in the Equity Investment account on the Parent’s balance sheet. In the consolidation process, they are explicitly recognized.
Solutions Manual, Chapter 2
©Cambridge Business Publishers, 2020 2-25
61.
a. The following acquisition date consolidated balance sheet can be used to answer questions a1-a7. Parent
Subsidiary
Dr
Cr
Consolidated
Assets: Cash
$700,000
$200,000
$900,000
Accounts receivable
300,000
400,000
700,000
Inventory
450,000
500,000
950,000
1,920,000
-
[E]
1,150,000
-
-
[A]
770,000
1,500,000
900,000
[A]
License Agreement
-
-
Customer List
-
-
Goodwill
-
-
$4,870,000
$2,000,000
$5,720,000
Accounts payable
$150,000
$100,000
$250,000
Accrued liabilities
180,000
200,000
380,000
Long-term liabilities
1,000,000
550,000
1,550,000
Equity investment
PPE, net
1.
0
2.
400,000
2,800,000
3.
[A]
200,000
200,000
[A]
100,000
100,000
[A]
70,000
70,000
4.
Liabilities and equity:
Common stock
140,000
100,000
[E]
100,000
140,000
5.
APIC
2,000,000
150,000
[E]
150,000
2,000,000
6.
Retained earnings
1,400,000
900,000
[E]
900,000
1,400,000
7.
$4,870,000
$2,000,000
1,920,000
1,920,000
$5,720,000
b. We will report the License Agreement ($200,000), Customer List ($100,000), and Goodwill ($70,000). Previously, these assets were embedded in the Equity investment account on the Parent’s balance sheet. In the consolidation process, they are explicitly recognized.
©Cambridge Business Publishers, 2020 2-26
Advanced Accounting, 4th Edition
62.
a. Equity investment Common stock APIC
1,500,000 50,000 1,450,000
(to record the acquisition)
b. [E]
Common stock APIC Retained earnings Equity investment
100,000 200,000 600,000 900,000
(to eliminate the stockholders’ equity of the subsidiary as of the acquisition date)
[A]
120,000 300,000 60,000 120,000
Trademark Video library Patented technology Goodwill Equity investment
600,000
(to record the Trademark, Video Library, Patented Technology, and Goodwill {a} assets)
c. Parent
Subsidiary
Dr
Cr
Consolidated
Assets: Cash
$250,000
$120,000
$370,000
Accounts receivable
200,000
300,000
500,000
Inventory
300,000
400,000
700,000
Equity investment
1,500,000
PPE, net
2,000,000
[E]
900,000
[A]
600,000
800,000
0 2,800,000
Trademark
[A]
120,000
120,000
Video Library
[A]
300,000
300,000
Patented Technology
[A]
60,000
60,000
Goodwill
[A]
120,000
120,000
$4,250,000
$1,620,000
$4,970,000
Accounts payable
$200,000
$80,000
$280,000
Accrued liabilities
250,000
140,000
390,000
Long-term liabilities
1,800,000
500,000
2,300,000
400,000
100,000
[E]
100,000
Liabilities and equity:
Common stock APIC Retained earnings
Solutions Manual, Chapter 2
400,000
600,000
200,000
[E]
200,000
1,000,000
600,000
[E]
600,000
0
1,000,000
600,000
$4,250,000
$1,620,000
$1,500,000
$1,500,000
$4,970,000
©Cambridge Business Publishers, 2020 2-27
d. We recognized four intangible assets in the consolidation process: the Trademark, the Video Library, Patented Technology and Goodwill. Previously, these assets were embedded in the Equity investment account on the Parent’s balance sheet. In the consolidation process, they are explicitly recognized. 63.B
a. Equity investment Common stock APIC (to record the Equity investment and issuance of shares)
1,500,000 120,000 1,380,000
b. Parent
Subsidiary
Dr
Cr
Consolidated
Assets: Cash
$200,000
$80,000
Accounts receivable
300,000
120,000
420,000
Inventory
700,000
600,000
1,300,000
Equity investment PPE, net
$280,000
1,500,000 2,000,000
[E]
880,000
[A]
620,000
0
1,000,000 [A]
100,000
3,100,000
Customer List
[A]
160,000
160,000
Brand Name
[A]
240,000
240,000
Goodwill
[A]
220,000
220,000
$4,700,000
$1,800,000
$5,720,000
Accounts payable
$150,000
$120,000
$270,000
Accrued liabilities
250,000
200,000
450,000
Long-term liabilities
1,600,000
600,000
Liabilities and equity:
2,200,000
Deferred income tax liability Common stock
[A]
100,000
100,000
500,000
80,000 [E]
80,000
500,000
APIC
1,000,000
200,000 [E]
200,000
1,000,000
Retained earnings
1,200,000
600,000 [E]
600,000
0
1,200,000
1,600,000
1,600,000
$5,720,000
$4,700,000
$1,800,000
Notes: 1. A deferred tax liability of $100,000 is established for the book-tax difference of $100,000 related to the PPE assets, $160,000 for the customer list, and $240,000 for the brand name asset (i.e., $500,000 total book-tax difference) multiplied by the tax rate of 20%. continued
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Advanced Accounting, 4th Edition
b. continued Notes continued: 2. Goodwill is computed as follows: Value of consideration Less: Fair value of identifiable net assets Deferred income tax liability Goodwill 64.
$1,500,000
$1,380,000 (100,000)
1,280,000 $ 220,000
a. Gilead need to demonstrate that Kite was a business. The FASB is careful to note that an integrated set of activities and assets requires only two essential elements: at least one input and at least one substantive process. The factors that provide evidence that a process is “substantive” depend on whether the group of net assets has produced outputs. If the group of net assets has not yet produced outputs, then a substantive process would include an organized workforce of employees with the knowledge and experience to perform or apply an acquired process that is critical to the ability to develop or convert an input into outputs. If the acquired group of net assets has already produced outputs, then a substantive process would include an organized workforce that can continue to produce that output or a process that significantly contributes to producing outputs, but that cannot be replaced without significant cost (i.e., these costs can be in terms of monetary outlay or delay in the ability to continue to produce outputs). With respect to outputs, it is important to note that the business definition is focused on whether a group of net assets is “. . . capable of being conducted and managed for the purpose of providing a return.” Thus, the fact that the group of net assets, prior to acquisition, had little or no outputs does not preclude its being considered a business. Generally speaking, an output is the result of processes applied to inputs, and is the factor that generates revenues from the acquired group of net assets. b. Kite only had assets: cash, identifiable intangible assets, deferred income taxes, goodwill and “other assets acquired (liabilities assumed), net” of only $81 million. One usually thinks of a business of having operations that support significant assetbased and liability-based working capital accounts.
Solutions Manual, Chapter 2
©Cambridge Business Publishers, 2020 2-29
c. First, any acquisition costs would be capitalized and allocated to the basket of fixed assets acquired (i.e., based on relative fair values). Second, the IPR&D would be expensed immediately instead of being capitalized. d. If the technology was proven and patented, then Yescarta would be separately recognized as an intellectual property asset and amortized over its expected (economic) useful life. 65.
a. Because of the complexity inherent in business combinations, it is not uncommon for the accounting to take some time to complete. FASB ASC 805-10-25-13 through 25-19 permits companies to use “provisional” amounts, and to retrospectively adjust those amounts when better information becomes available, provided that the final measurement of all assets and liabilities is completed within one year from the acquisition date. Also, during the measurement period, the investor can recognize additional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets and liabilities as of that date. Beginning in 2015, the adjustments are recognized prospectively (i.e., no longer retroactively), with the incremental adjustment fully recognized in the period in which the measurement was changed. b. In $millions Equity investment SG&A Expenses
3,200.5 76.6 Cash
3,277.1
Note that the $5,100.0 purchase price included in the first sentence of the footnote assumes that the debt held by Bally was issued by Scientific Games because the debt was refinanced as part of the acquisition. Debt refinancing is not uncommon in business combinations, but ASC 805 precludes the assumption or refinancing of acquired debt to be included in the purchase price. Therefore, the $3,200.5 investment account includes the refinanced debt (i.e., $5,100 ‒ $1,899.5* = $3,200.5). *(approximately $1.9 billion in debt)
c. The value assigned to Goodwill is not computed directly. Instead, it is computed as a residual amount (i.e., the amount left over after all other assets and liabilities have been identified and valued).
©Cambridge Business Publishers, 2020 2-30
Advanced Accounting, 4th Edition
d. Scientific Games assigned a total fair value of $1,575.3 million to amortizable intangible assets (i.e., $1,800.3 - $225.0). FASB ASC 805-20-30-1 requires that, as of the acquisition date, “The acquirer shall measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their acquisition-date fair values,” and FASB ASC 820-10-20 defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Companies can estimate these fair values using a “market approach,” an “income approach,” or a “cost approach.” Each of these approaches requires significant estimates. The estimated fair values of acquired finite and indefinite-lived trade names and finite-lived internally-developed intellectual property ("IP") was determined using the royalty savings method, which is a risk-adjusted discounted cash flow approach. Finite-lived intangible assets valued using the royalty savings method include gaming content and operating system software, casino management systems and game server software (all included within software above), certain product trade names and game cabinet design IP (included in core technology and content above). The royalty savings method values an intangible asset by estimating the royalties saved through ownership of the asset. The royalty savings method requires identifying the future revenue that would be impacted by the trade name or IP asset (or royaltyfree rights to the assets), multiplying it by a royalty rate deemed to be avoided through ownership of the asset and discounting the projected royalty savings amounts back to the acquisition date. The royalty rate used in such valuation was based on a consideration of market rates for similar categories of assets…. The estimated fair values of the acquired PTG IP and Utility products IP (both included in core technology and content above) and customer relationships were determined using the excess earnings method, which is a risk-adjusted discounted cash flow approach that determines the value of an intangible asset as the present value of the cash flows attributable to such asset after excluding the proportion of the cash flows that are attributable to other assets. The contribution to the cash flows that are made by other assets - such as fixed assets, working capital, workforce and other intangible assets, including trade names and game content and design IP was estimated through contributory asset capital charges. The value of the acquired customer relationship asset is the present value of the attributed post-tax cash flows, net of the post-tax return on fair value attributed to the other assets…
Solutions Manual, Chapter 2
©Cambridge Business Publishers, 2020 2-31
e. Trade names Brand names Core technology and content Customer relationships Long-term licenses Total Amortization
FV 225.0 90.7
Life Indefinite 9.20
734.7 726.0 23.9
7.20 15.10 3.00
Amort $
9.9
102.0 48.1 8.0 $168.0
f. Bally’s performance is included in Scientific Games’ revenues and expenses for the period after the November 21, 2014 acquisition date. According to the disclosure, the revenues and loss for the period November 21, 2014 through December 31, 2014 are as follows:
Revenue Loss from continuing operations
From November 21, 2014 through December 31, 2014 $ 151.6 $ (21.1)
g. Assuming no intercompany transactions, Scientific Games indicates that “Revenue from Consolidated Statements of Operations” is $1,786.4. This amount includes the $151.6 of Bally revenue from November 21, 2014 through December 31, 2014 (see answer to f, above). In that same disclosure, Scientific Games also provides unaudited pro-forma consolidated revenue “as if” Bally was included in Scientific Games income statement for the entire year. As part of that disclosure, Scientific Games also reports that Bally had $1,159.5 of revenue for the period January 1, 2014 through November 20, 2014. Thus, Bally’s revenue for the twelve months ending December 31, 2014 would have been approximately $1,311.1 (i.e., $1,159.5 + $151.6). h. Scientific Games credits the Equity Investment account for its book value of $3,200.5 million to remove that account from the consolidated balance sheet. The offsetting debits and credits will remove the beginning-of-year stockholders’ equity of Bally and recognizes, as reported assets and liabilities on the consolidated balance sheet, the excess of the fair value of the acquired assets and liabilities assumed in excess of their respective book values.
©Cambridge Business Publishers, 2020 2-32
Advanced Accounting, 4th Edition
Advanced Accounting Fourth Edition By Patrick E. Hopkins and Robert F. Halsey
Solution Manual Chapter 3— Consolidated Financial Statements Subsequent to the Date of Acquisition 1.
If the parent uses the equity method of accounting, it recognizes the Equity Income of the subsidiary, less the depreciation and amortization of the [A] AAP net assets, in the Equity Income account on its income statement. In the consolidation process, this Equity Income account is eliminated and replaced with the revenues and expenses to which it relates. Net income is unaffected because we are replacing the subsidiary’s net income (reported in Equity Income) with its revenues and expenses.
2.
The parent and the subsidiary it controls are viewed as one entity under GAAP. Therefore, only payments of dividends outside of the controlled group affect consolidated Retained Earnings. Another way of looking at it is this: consolidated Retained Earnings represent the cumulative earnings that are available for dividends to the parent’s stockholders. The payment of cash from the subsidiary to its parent only transfers cash from one company to another. That cash is still available to pay dividends up to the remaining balance in consolidated Retained Earnings.
3.
Under the cost method, the parent company, in computation of its pre-consolidation net income, does not include its proportional share of the subsidiary’s net income or the AAP amortization. Instead, the parent company, in computation of its pre-consolidation net income, includes its proportional share of the subsidiary’s dividends. Thus, to convert the parent company’s pre-consolidation net income from cost to equity method, the parent company would deduct the dividends received from the subsidiary, add its proportionate share of the subsidiary’s net income and deduct the proportionate share of the AAP amortization. The relation between the resulting parent company equity method pre-consolidation net income and consolidated net income is that they are the same.
Solutions Manual, Chapter 3
©Cambridge Business Publishers, 2020 3-1
4.
Under the cost method, the parent company, in computation of its pre-consolidation retained earnings, accumulates net income that does not include the parent’s proportional share of the subsidiary’s net income or the AAP amortization. Instead, the parent company, in computation of its pre-consolidation retained earnings, accumulates net income that includes its proportional share of the subsidiary’s dividends. Thus, to convert the parent company’s pre-consolidation retained earnings from cost to equity method, the parent company would deduct the accumulated dividends (since acquisition) received from the subsidiary, add its accumulated proportionate share of the subsidiary’s net income (since acquisition) and deduct the proportionate share of the accumulated AAP amortization (since acquisition). These three adjustments net to the same amount as adding its proportionate share of the change in retained earnings (i.e., net income minus dividends) of the subsidiary since acquisition and deducting its proportionate share of the accumulated AAP amortization (since acquisition). The relation between the resulting parent company equity method pre-consolidation retained earnings and consolidated retained earnings is that they are the same.
5.
The Equity Investment account appears on the balance sheet of the parent and represents the proportion of the Stockholders’ Equity of the subsidiary that it owns. In the consolidation process, we eliminate the Equity Investment account and replace it with the assets and liabilities of the subsidiary to which it relates. Since assets = liabilities + equity (equity = assets – liabilities), the dollar amount of the Equity Investment account must equal the subsidiary’s assets less its liabilities (i.e., net assets). Although total assets and total liabilities change, consolidated Stockholders’ Equity remains unchanged in the consolidation process.
6.
The Equity Investment account on the parent’s balance sheet includes all of the assets it purchased less the liabilities it assumed in the acquisition (less any subsequent depreciation and amortization of the AAP). In the consolidation process, those unrecorded net assets and liabilities, that were previously included in the Equity Investment account, are broken out separately on the consolidated balance sheet.
7.
The consolidated statement of cash flows reports the cash inflows and outflows between the consolidated entity and outside parties. Intercompany transfers of cash do not generate or use cash on a consolidated basis. The consolidation process eliminates intercompany transactions. As a result, the consolidated statement of cash flows should be prepared from the consolidated income statement and comparative consolidated balance sheets.
©Cambridge Business Publishers, 2020 3-2
Advanced Accounting, 4th Edition
8.
Goodwill is a residual asset, which means that it is the amount left over after we have first allocated the purchase price to all other assets (tangible and intangible) purchased and liabilities assumed. The FASB ASC Glossary defines goodwill as “an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.” Goodwill is not valued directly as are all other assets and liabilities that are acquired in an acquisition. Instead, the value of Goodwill is inferred from the total consideration given to the acquiree less the fair value of the net tangible and intangible assets (other than Goodwill) that are acquired.
9.
In the absence of a market price for the subsidiary’s shares, the parent can use any reasonable basis for determining the value of the subsidiary, including discounted cash flows (DCF) and a multiple of earnings (ASC 350-20-35-22 through 35-24).
10.
There are a number of situations that would require impairment testing in between annual reviews (FASB ASC 350-20-35-30): a. A significant adverse change in legal factors or an adverse action or assessment by a regulator, b. A significant adverse change in the business climate or unanticipated competition, c. A loss of key personnel, d. An expectation that the investee company will be sold, and e. Recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit.
11.
FASB ASC 805-10-50-2 requires the following general disclosures in the footnotes in the year of acquisition and for each year in which comparative information is provided (the subsequent two years): a. The name and a description of the acquiree. b. The acquisition date. c. The percentage of voting equity interests acquired. d. The primary reasons for the business combination and a description of how the acquirer obtained control of the acquire.
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e. For transactions that are recognized separately from the acquisition of assets and assumptions of liabilities in the business combination (see paragraph 805-10-25-20), all of the following: 1. A description of each transaction 2. How the acquirer accounted for each transaction 3. The amounts recognized for each transaction and the line item in the financial statements in which each amount is recognized 4. If the transaction is the effective settlement of a preexisting relationship, the method used to determine the settlement amount. f. The disclosure of separately recognized transactions required in (e) shall include the amount of acquisition-related costs, the amount recognized as an expense, and the line item or items in the income statement in which those expenses are recognized. The amount of any issuance costs not recognized as an expense and how they were recognized also shall be disclosed. g. In a business combination achieved in stages, both of the following: 1. The acquisition-date fair value of the equity interest in the acquiree held by the acquirer immediately before the acquisition date 2. The amount of any gain or loss recognized as a result of remeasuring to fair value the equity interest in the acquiree held by the acquirer before the business combination (see paragraph 805-10-25-10) and the line item in the income statement in which that gain or loss is recognized h. If the acquirer is a public business entity, all of the following: 1. The amounts of revenue and earnings of the acquiree since the acquisition date included in the consolidated income statement for the reporting period 2. The revenue and earnings of the combined entity for the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period (supplemental pro forma information) 3. If comparative financial statements are presented, the revenue and earnings of the combined entity for the comparable prior reporting period as though the acquisition date for all business combinations that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period (supplemental pro forma information). If disclosure of any of the information required by (h) is impracticable, the acquirer shall disclose that fact and explain why the disclosure is impracticable. In this context, the term impracticable has the same meaning as in paragraph 250-10-45-9. ©Cambridge Business Publishers, 2020 3-4
Advanced Accounting, 4th Edition
12.
Following are some of the limitations of consolidated financial statements: a. Consolidated income does not imply that the parent company has received any or all of the subsidiaries’ net income as cash. b. Unguaranteed debts of a subsidiary are not obligations of the consolidated group. c. Consolidated balance sheets and income statements are a mix of the various subsidiaries, often from different industries. d. Segment disclosures on individual subsidiaries are affected by intercorporate transfer pricing policies. e. Segment disclosures are often too summarized for effective analysis.
13.
The following guidance is provided in the FASB ASC 350-30-55-2 through 55-20: a. The customer list would be amortized over 18 months, management’s best estimate of its useful life, following the pattern in which the expected benefits will be consumed or otherwise used up. b. The patent would be amortized over its five-year useful life to the reporting entity following the pattern in which the expected benefits will be consumed or otherwise used up. The amount to be amortized is 40 percent of the patent’s fair value at the acquisition date (residual value is 60 percent). c. The copyright would be amortized over its 30-year estimated useful life following the pattern in which the expected benefits will be consumed or otherwise used. d. The broadcast license would be deemed to have an indefinite useful life because cash flows are expected to continue indefinitely. Therefore, the license would not be amortized until its useful life is deemed to be no longer indefinite. The license would be tested for impairment annually. e. The trademark would be deemed to have an indefinite useful life because it is expected to contribute to cash flows indefinitely. Therefore, the trademark would not be amortized until its useful life is no longer indefinite. The trademark would be tested for impairment at least annually.
14.
The following guidance is provided in FASB ASC 350-30-35-1 through 35-20: as a result of the projected decrease in future cash flows, since the company determines that the estimated fair value of the trademark ($10 million) is less than its carrying amount ($30 million), an impairment loss of $20 million should recognized. The amount not written off ($10 million) will continue to not be amortized because it is still deemed to have an indefinite useful life. The remaining balance of the trademark will, however, continue to be tested for impairment.
Solutions Manual, Chapter 3
©Cambridge Business Publishers, 2020 3-5
15.
Following are provisions of FASB ASC 805-20-25-2 and FASB Concept Statement #6 relating to restructuring activities. a. Typical restructuring activities include the costs of a plan to exit an activity of an acquiree or to terminate the employment of or relocate an acquiree’s employees. b. A liability is defined in FASB Concepts Statement No. 6, Elements of Financial Statements as, “probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.” FASB ASC 805-20-252 provides the following guidance with respect to the accounting for restructuring costs: “costs the acquirer expects but is not obligated to incur in the future to affect its plan to exit an activity of an acquiree or to terminate the employment of or relocate an acquiree’s employees are not liabilities at the acquisition date. Therefore, the acquirer does not recognize those costs as part of applying the acquisition method. Instead, the acquirer recognizes those costs in its postcombination financial statements in accordance with other applicable generally accepted accounting principles (GAAP).” (emphasis added) Bottom line, unless the subsidiary has already adopted a plan and is obligated for its completion (in which case the expense would have already been recognized in its financial statements), the restructuring liability and related expense should not be recognized at acquisition. Instead, those costs should be recognized in the future when the restructuring plan is adopted.
16.
Answer: b Each statement is true, except for b. For passive noncontrolling marketable equity investments with readily determinable fair values, the investor must measure the investments at fair value at each balance sheet date and report the change in fair value as part of net income. This question reviews a wide variety of concepts that should have been covered in previous courses and that integrate with topics in this textbook. (Note that in early 2016, the FASB eliminated the separate trading and available for sale categories for passive investments in equity securities. Instead, all changes in fair value for passive equity investments (that have readily determinable fair values) are immediately reflected in net income. These rules took effect for public business entities for fiscal years beginning after December 15, 2017 (e.g., in 2018 for a calendar-year public company), and for all other entities (e.g., private companies) for fiscal years beginning after December 15, 2018.)
17.
Answer: d Each statement is true, except for d. The fair value option is available for all equity investments, except for controlling investments in subsidiaries.
©Cambridge Business Publishers, 2020 3-6
Advanced Accounting, 4th Edition
18.
Answer: d Under the equity method, when there are no intercompany profits between affiliated companies, the pre-consolidation investment at any point in time can be determined via the following equation: Investment in Subsidiary = p% x stockholders equity of S + unamortized p% AAP Given that this is a 100% investment and there is no AAP or fair value-book value differences for the net assets of the subsidiary on the acquisition date, then, on any date, the pre-consolidation investment account will equal the stockholders’ equity of the Subsidiary on that date. SE(S) on 12/31/19 = $600,000
19.
Answer: b Under the equity method, when there are no intercompany profits between affiliated companies, the pre-consolidation income from investee for any given year can be determined via the following equation: Income from Subsidiary = p% x NI(S) - p% AAP for the period Given that this is a 100% investment and there is no AAP or fair value-book value differences for the net assets of the subsidiary, then, for any period after the acquisition, the Income from Subsidiary account will equal the net income of the Subsidiary for that period. NI(S) for the year ended 12/31/19 = $95,000
20.
Answer: b Under the cost method, the pre-consolidation investment at any point in time will equal the investment on the acquisition date. Given that there is no AAP or fair value-book value differences, the investment account equals p% x the stockholders equity on the acquisition date. In this problem, we are given the stockholder equity at 12/31/17. We need to back out the changes in stockholders equity during 2017 to back into the stockholders equity on 1/1/17(i.e., SE(S)12/31/17 – NI(S)2017 + Div(S)2017 = SE(S)1/1/17). Thus, the pre-consolidation investment account on 1/1/17 equals $450,000 (i.e., $500,000 $75,000 + $25,000), which is also the balance under the cost method on December 31, 2019.
21.
Answer: a Under the cost method, the pre-consolidation income from investee is equal to the dividends received from the investee (i.e., $40,000 for the year ended 12/31/19).
Solutions Manual, Chapter 3
©Cambridge Business Publishers, 2020 3-7
22.
Answer: b Under the equity method, when there are no intercompany profits between affiliated companies, the pre-consolidation investment at any point in time can be determined via the following equation: Investment in Subsidiary = p% x stockholders equity of S + unamortized p% AAP In this case, the acquisition-date AAP was equal to $331,250 (i.e., $112,500 + $218,750). The $112,500 is amortized over 6 years, which means it is amortized at a rate of $18,750/year. After three years, it has an unamortized balance of $56,250. The $218,750 represents goodwill, which is not amortized. Thus, the pre-consolidation balance in the investment account can be calculated as follows: Investment in Subsidiary12/31/19 = (100% x 600,000) of S + ($56,250 + $218,750) = $875,000
23.
Answer: c Under the equity method, when there are no intercompany profits between affiliated companies, the pre-consolidation income from investee for any given year can be determined via the following equation: Income from Subsidiary = p% x NI(S) - p% AAP for the period In this case, the acquisition-date AAP was equal to $331,250 (i.e., $112,500 + $218,750). The $112,500 is amortized over 6 years, which means it is amortized at a rate of $18,750/year. After three years, it has an unamortized balance of $56,250. The $218,750 represents goodwill, which is not amortized. Thus, the pre-consolidation amount in the income from investee account can be calculated as follows: Income from Subsidiary2019 = p% x NI(S) ‒ p% AAP for the period = (100% x $95,000) ‒ $18,750 = $76,250
©Cambridge Business Publishers, 2020 3-8
Advanced Accounting, 4th Edition
24.
Answer: b Under the cost method, the parent does not adjust its pre-consolidation equity investment account after the acquisition date. In addition, the parent company does not recognize the equity-method income statement effects in its pre-consolidation income statements. Because retained earnings is the place where income statement effects accumulate over time, this means that the parent company’s pre-consolidation retained earnings will move further away from the amount of the consolidated beginning balance of retained earnings. (Recall that, under the equity method, the parent’s reconsolidation net income and stockholders’ equity is the same as consolidated income attributable to the controlling interest and consolidated retained earnings. As we describe in the text, when the parent company uses the cost method, the way to arrive at the correct consolidated beginning balance of retained earnings is to make the following adjustment to beginning retained earnings and to the investment account: [ADJ] = (p% x Change in subsidiary RE since acquisition thru BOY) – accum p% AAP amort. thru BOY In this case, p% = 100%, so the amount of the [ADJ] is computed as follows: [ADJ] = ($345,000 – $250,000) – ($18,750 + $18,750) = $95,000 – $37,500 = $57,500
25.
Answer: d When the parent company uses the cost method, the income from investee will equal p% x investee dividends. In this case, p% = 100%. The [C] will eliminate the income from investee, and the dividends declared by the investee equals $40,000 during 2019.
26.
Answer: a Goodwill = FV entire subsidiary – FV Identifiable net assets of the subsidiary When an investor purchases 100% of a subsidiary in a single transaction, the purchase price is presumed to represent the FV of the entire subsidiary (i.e., $5,920,000 in this case). We can determine the FV of the identifiable net assets (FVINA) by taking the reported book value of the net assets (BVNA) of the subsidiary and adding any fair-value book value differences. In this case, the FVINA(S) equals $4,160,000 (i.e., $3,040,000 + $1,120,000). Thus the goodwill equals $1,760,000 (i.e., $5,920,000 - $4,160,000).
Solutions Manual, Chapter 3
©Cambridge Business Publishers, 2020 3-9
Note: For questions 27-30, the following is the implied consolidation spreadsheet based on the facts in the problem. Note that this competed spreadsheet was not required. However, this worksheet could be used as an effective tool in discussing the various subparts of the multiple choice problems. Income Statement Revenues Income from Investee Expenses Consol. Net Income NCI
Investor $2,232,000 141,600 (1,800,000) 573,600
Investee $307,200 0 (156,000) 151,200
$573,600
$151,200
$720,000 573,600 (60,000) $1,233,600
$36,000 151,200 (36,000) $151,200
$283,200
$-
All Other Assets Total Assets
4,598,400 $4,881,600
384,000 $384,000
Liabilities Common Stock & APIC Retained Earnings Total Liabilities and Equity
$2,880,000 768,000 1,233,600 $4,881,600
$148,800 84,000 151,200 $384,000
Net Income Retained Earnings Statement Retained Earnings, January 1 Net Income Dividends declared Retained Earnings, December 31 Balance Sheet Investment in Investee
©Cambridge Business Publishers, 2020 3-10
Dr [C] [D]
Cr
141,600 9,600
Consol 2,539,200 (1,965,600) 573,600 573,600
[E]
[A]
[E]
36,000
57,600
[C]
36,000
[C] [E] [A] [D]
105,600 120,000 57,600 9,600
84,000 328,800
328,800
720,000 573,600 (60,000) 1,233,600
-
5,030,400 5,030,400 3,028,800 768,000 1,233,600 5,030,400
Advanced Accounting, 4th Edition
27.
Answer: c Given that there are no intercompany transactions between the investor and the investee, the amount of consolidated expenses will equal the parent’s expenses plus the subsidiary expenses, adjusted of any acquisition accounting premium (AAP) amortization. Although we are not given the AAP amortization, we can infer the amount by comparing the Income from Investee account to the Net income of the investee. Because p% = 100%, any difference is equal to the AAP amortization. In this case, AAP amortization during the year ended December 31, 2019 equals $9,600 (i.e., $151,200 $141,600). Thus, consolidated expenses can be determined as follows: Consolidated expenses = Expenses (P) + Expenses (S) + AAP Amortization = $1,800,000 + $156,000 + $9,600 = $1,965,600
28.
Answer: b Given that there are no intercompany transactions between the investor and the investee (or related intercompany profits) and the parent uses the equity method, then the reported pre-consolidation net income of the parent company equals consolidated net income (i.e., $573,600).
29.
Answer: c Given that the parent uses the equity method, then the reported pre-consolidation retained earnings of the parent company equals consolidated retained earnings (i.e., $1,233,600).
30.
Answer: a Given that there are no intercompany transactions or related balances, then the amount of consolidated totals assets will equal the Parent’s total assets after deducting the investment account plus the subsidiary’s total assets plus the unamortized AAP implicit in the investment account at the end of the year. We will compute each of these items separately: •
Parent’s total assets after deducting the investment account = $4,881,600 – $283,200 = $4,598,400
•
Subsidiary’s total assets = $384,000
•
Unamortized AAP at December 31, 2019 = Investment12/31/2019 – SE(S)12/31/2019 = $283,200 – ($84,000 + $151,200) = $48,000
Adding these components together yields consolidated total assets equal to $5,030,400 (i.e., $4,598,400 + $384,000 + $48,000).
Solutions Manual, Chapter 3
©Cambridge Business Publishers, 2020 3-11
31. – =
Total value of the consideration given Fair value of the tangible and intangible assets Goodwill
$2,100,000 1,614,000 $ 486,000
The Goodwill asset is not amortized since it is deemed to have an indefinite life. Instead, it is tested at least annually for impairment and written down if found to be impaired. 32.
a. The amount of goodwill in this acquisition is computed as follows: – =
Total value of the consideration given Fair value of the tangible and intangible assets Goodwill
$3,040,000 1,752,000 $1,288,000
The Goodwill asset is not amortized since it is deemed to have an indefinite life. Instead, it is tested at least annually for impairment and written down if found to be impaired. b. The total value of the consideration increases by $176,000. Since the fair value of the net tangible and intangible assets is unchanged, the amount assigned to the Goodwill asset increases by $176,000. c. The goodwill computation is as follows: – =
Total value of the consideration given Fair value of the tangible and intangible assets Goodwill
$3,040,000 3,512,000 $(472,000)
This is a bargain purchase. Assuming a cash purchase for all of the outstanding voting shares of the acquiree, the acquisition would be recorded as follows: Equity investment Cash Gain on bargain purchase
3,512,000 3,040,000 472,000
(to record the acquisition and bargain purchase)
©Cambridge Business Publishers, 2020 3-12
Advanced Accounting, 4th Edition
33.
a. Goodwill impairment testing must be conducted annually, and on approximately the same date each year. Companies can either elect to proceed directly to the quantitative impairment test, or avail themselves of the opportunity to conduct a qualitative impairment test. If a company elects to conduct a qualitative impairment test, then the company must conduct a quantitative impairment test if the relevant events and circumstances indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. b. Because the fair value of the Equity Investment ($4,500,000) is below its carrying amount ($5,020,000), Goodwill is potentially impaired and you should proceed to the second part of the test for impairment. The implied value of goodwill is computed as follows: Fair value of the subsidiary Fair value of the net assets exclusive of goodwill Implied fair value of goodwill Book value of goodwill Goodwill impairment
$ 4,500,000 4,300,000 200,000 480,000 $ (280,000)
The goodwill is found to be impaired. c. Goodwill must be written down to its implied value of $200,000 with the following journal entry: Equity income from S Equity investment
280,000 280,000
(to write down the book value of goodwill)
Goodwill will now be reported on the consolidated balance sheet at $200,000, and a loss on the write-down of goodwill will be reported in the consolidated income statement. The goodwill asset cannot be subsequently written up should the fair value of the subsidiary improve. 34.
a. Goodwill impairment testing must be conducted annually, and on approximately the same date each year. Companies can either elect to proceed directly to the quantitative impairment test, or avail themselves of the opportunity to conduct a qualitative impairment test. If a company elects to conduct a qualitative impairment test, then the company must conduct a quantitative impairment test if the relevant events and circumstances indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying amount.
Solutions Manual, Chapter 3
©Cambridge Business Publishers, 2020 3-13
b. After adoption of ASC 2017-04, Goodwill is assumed to be impaired when the carrying value of a reporting unit exceeds to fair value of that reporting unit. In addition, the amount by which the carrying value of the (entire) reporting unit exceeds the fair value of the (entire) reporting unit will be completely attributable to impaired goodwill. (If the amount by which the carrying value of the reporting unit exceeds the fair value of the reporting unit is greater than the goodwill balance, then the impairment is limited by the goodwill balance. That is, when this occurs, goodwill is written down to a zero balance with no further impairment recognized as a result of the goodwill impairment test.) In this exercise, the fair value of the Equity Investment (i.e., the reporting unit) is $4,500,000, which is below its carrying amount of $5,020,000. Thus, Goodwill is impaired. This difference of $520,000 is greater than the Goodwill balance of $480,000. Therefore, the amount of the Goodwill impairment is limited to the Goodwill balance of $480,000. c. Goodwill must be written down to its implied value of $0 with the following journal entry: Equity income from S Equity investment
480,000 480,000
(to write down the book value of goodwill)
The loss on the write-down of goodwill will be reported in the consolidated income statement. After impairment, Goodwill cannot be subsequently written up if the fair value of the subsidiary increases. 35.
a. Goodwill impairment testing must be conducted annually, and on approximately the same date each year. Companies can either elect to proceed directly to the quantitative impairment test, or avail themselves of the opportunity to conduct a qualitative impairment test. If a company elects to conduct a qualitative impairment test, then the company must conduct a quantitative impairment test if the relevant events and circumstances indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. b. Because the fair value of the Equity Investment ($2,750,000) is below its carrying amount ($2,950,000), Goodwill is potentially impaired and you should proceed to the second part of the test for impairment. The implied value of goodwill is computed as follows: Fair value of the subsidiary Fair value of the net assets exclusive of goodwill Implied fair value of goodwill Book value of goodwill Goodwill impairment
$ 2,750,000 2,500,000 250,000 150,000 $ 0*
* Because implied fair value of Goodwill is greater than the carrying value of Goodwill.
d. Given no Goodwill impairment exists, no journal entry is necessary. ©Cambridge Business Publishers, 2020 3-14
Advanced Accounting, 4th Edition
36.
a. Goodwill impairment testing must be conducted annually, and on approximately the same date each year. Companies can either elect to proceed directly to the quantitative impairment test, or avail themselves of the opportunity to conduct a qualitative impairment test. If a company elects to conduct a qualitative impairment test, then the company must conduct a quantitative impairment test if the relevant events and circumstances indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. b. After adoption of ASC 2017-04, Goodwill is assumed to be impaired when the carrying value of a reporting unit exceeds to fair value of that reporting unit. In addition, the amount by which the carrying value of the (entire) reporting unit exceeds the fair value of the (entire) reporting unit will be completely attributable to impaired goodwill. (If the amount by which the carrying value of the reporting unit exceeds the fair value of the reporting unit is greater than the goodwill balance, then the impairment is limited by the goodwill balance. That is, when this occurs, goodwill is written down to a zero balance with no further impairment recognized as a result of the goodwill impairment test.) In this exercise, the fair value of the Equity Investment (i.e., the reporting unit) is $2,750,000, which is below its carrying amount of $2,950,000. Thus, Goodwill is impaired. This difference of $200,000 is greater than the Goodwill balance of $150,000. Therefore, the amount of the Goodwill impairment is limited to the Goodwill balance of $150,000. c. Goodwill must be written down to its implied value of $0 with the following journal entry: Equity income from S Equity investment
150,000 150,000
(to write down the book value of goodwill)
The loss on the write-down of goodwill will be reported in the consolidated income statement. After impairment, Goodwill cannot be subsequently written up if the fair value of the subsidiary increases. d. If the fair value of the subsidiary is $2,810,000, then the reporting unit is impaired because the carrying value of reporting unit of $2,950,000 is still below the fair value. The difference between the fair value and the carrying value (i.e., $2,810,000 - $2,950,000 = $(140,000)) is the amount of the impairment because it is less than the Goodwill balance. Goodwill must be written down to its implied value of $10,000 with the following journal entry: Equity income from S Equity investment
140,000 140,000
(to write down the book value of goodwill)
The loss on the write-down of goodwill will be reported in the consolidated income statement. After impairment, Goodwill cannot be subsequently written up if the fair value of the subsidiary increases. Solutions Manual, Chapter 3
©Cambridge Business Publishers, 2020 3-15
37.
a. The allocation of the purchase price to the restructuring liability reduced the dollar amount of net identifiable assets recognized and, as a result, increased the dollar amount of goodwill recognized by $41.2 million. b. The restructuring liability was accrued by Elan (the target company) prior to the acquisition. As a result, the associated expense was reflected in Elan’s income statement before the acquisition. c. As Perrigo makes payments under the restructuring plan, the debit will be to the restructuring liability that it recognized in the acquisition, not to an expense account. As a result, Perrigo’s post-acquisition pretax profit will be $41.2 million higher.
38.
Working capital—Normal accounting for collection of receivables, payment of payables, etc. Inventories—Normal accounting for removal of inventories and recognition of cost of goods sold. Property, plant and equipment – Depreciation over useful life. Identifiable intangible assets—Amortization over useful life. In-process research & development—Write off if abandoned, amortize over useful life when completed if not abandoned. Other noncurrent assets—Depreciate/amortize over useful life and test for impairment annually. Long-term debt—Amortize (increase) the carrying amount with the offsetting debit to expense. Benefit obligations—Amortize (increase) the carrying amount with the offsetting debit to expense. Net tax accounts—Record reduction of the liability as taxes are paid as is customary for deferred tax liabilities. Other noncurrent liabilities—Reduce when paid. Goodwill—No amortization. Test annually for impairment.
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Advanced Accounting, 4th Edition
39.
a. The $4.609 billion balance in the PPE account is the book value on Grupo Modelo’s balance sheet on the date of the acquisition. The addition of $0.99 billion reflects the AAP and the $4.708 billion is the fair value of the PPE assets on the date of acquisition. b. The Goodwill account represents the Goodwill asset on Grupo Modelo’s balance sheet on the date of the acquisition. AB InBev does not recognize the previously, existing goodwill asset. Instead, it only recognizes goodwill that is implicit in the assignment of the purchase price in the acquisition of Anheuser-Busch. c. This is the amount of incremental Goodwill recognized after zeroing out the old Goodwill (i.e., discussed in part (b)) on Grupo Modelo’s pre-acquisition balance sheet and considering the acquisition-date fair values of the identifiable net assets. d. This most likely relates to internally developed brands controlled by Grupo Modelo. e. The increase in Deferred Tax Liabilities reflects the expected taxes that will be paid on the higher value of the net assets acquired.
40.
a. Sales = $6,000,000 + $1,500,000 = $7,500,000 b. Equity income = $0 c. Operating expenses = $1,000,000 + $400,000 + $30,000 = $1,430,000 d. Accounts receivable = $1,000,000 + $348,000 = $1,348,000 e. Equity investment = $0 f. PPE, net = $4,800,000 + $824,000 + $330,000 ‒ $30,000 = $5,924,000 g. Goodwill = $400,000 h. Common stock = $640,000 i.
Retained earnings = $2,640,000
Solutions Manual, Chapter 3
©Cambridge Business Publishers, 2020 3-17
41.
a. Cost of goods sold = $2,000,000 + $500,000 = $2,500,000 b. Equity income = $0 c. Operating expenses = $450,000 + $200,000 + $50,000 = $700,000 d. Cash = $700,000 + $100,000 = $800,000 e. Equity investment = $0 f. PPE, net = $3,000,000 + $800,000 = $3,800,000 g. Patent = $350,000 h. Goodwill = $300,000
42.
i.
Common stock = $500,000
j.
Retained earnings = $3,000,000
a. Sales = $3,000,000 + $800,000 = $3,800,000 b. Equity income = $0 c. Operating expenses = $1,000,000 + $150,000 + $40,000 = $1,190,000 d. Inventories = $800,000 + $280,000 = $1,080,000 e. Equity Investment = $0 f. PPE, net = $3,000,000 + $600,000 + $70,000 ‒ $10,000 = $3,360,000 g. Patent = $150,000 ‒ $30,000 = $120,000 h. Common Stock = $400,000 i.
Retained Earnings = $2,010,000
©Cambridge Business Publishers, 2020 3-18
Advanced Accounting, 4th Edition
43.
a. Sales = $5,000,000 + $1,200,000 = $6,200,000 b. Investment income = $0 c. Operating expenses = $1,500,000 + $400,000 + $25,000 = $1,925,000 d. Inventories = $1,600,000 + $500,000 = $2,100,000 e. Equity Investment = $0 f. PPE, net = $3,000,000 + $900,000 + $225,000 ‒ $25,000 = $4,100,000 g. Goodwill = $400,000 h. Common Stock = $500,000 i.
44.
Retained Earnings = $1,840,000 + ($660,000 ‒ $280,000) – (2 x $25,000) = $2,170,000
a. Sales = $2,400,000 + $900,000 = $3,300,000 b. Investment income = $0 c. Operating expenses = $600,000 + $250,000 + $50,000 = $900,000 d. Inventories = $2,400,000 + $500,000 = $2,900,000 e. Equity Investment = $0 f. PPE, net = $4,000,000 + $1,000,000 + $300,000 ‒ $50,000 = $5,250,000 g. Goodwill = $250,000 h. Common Stock = $500,000 i.
45.
Retained Earnings = $1,800,000 + ($550,000 ‒ $80,000) – (3 x $50,000) = $2,120,000
a. Sales = $3,500,000 + $1,600,000 = $5,100,000 b. Investment income = $0 c. Operating expenses = $1,000,000 + $600,000 + $75,000 = $1,675,000 d. Inventories = $1,400,000 + $500,000 = $1,900,000 e. Equity Investment = $0 f. PPE, net = $4,500,000 + $900,000 + $325,000 ‒ $25,000 = $5,700,000
Solutions Manual, Chapter 3
©Cambridge Business Publishers, 2020 3-19
g. Patent = $100,000 h. Goodwill = $200,000
46.
i.
Common Stock = $1,000,000
j.
Retained Earnings = $2,300,000 + ($800,000 ‒ $360,000) – (4 x $75,000) = $2,440,000
a. Equity investment Common stock APIC
600,000 30,000 570,000
(to record the acquisition)
b. Beginning Equity Investment Equity income Dividends Ending Equity Investment
$600,000 180,000 (50,000) $730,000
c. [C]
[E]
Equity income (P) Dividends (S) Equity investment (P) (to eliminate all changes in the Equity Investment account, leaving only beginning balance in the account)
180,000
Common stock (S) @ BOY APIC (S) @ BOY Retained earnings (S) @ BOY Equity Investment (P) @ BOY (to eliminate the portion of the investment account related to the book value of the subsidiary's Stockholders' Equity @ BOY)
200,000 300,000 100,000
[A]
No Accounting Acquisition Premium
[D]
No (AAP) in problem
[I]
No intercompany items in problem
©Cambridge Business Publishers, 2020 3-20
50,000 130,000
600,000
Advanced Accounting, 4th Edition
46.
d. Income Statement
Parent
Subsidiary
Sales
3,000,000
1,740,000
4,740,000
Cost of goods sold
(1,600,000)
(960,000)
(2,560,000)
Gross profit
1,400,000
780,000
2,180,000
Equity income
180,000
Operating expenses Net income
Dr
[C]
Cr
Consolidated
180,000
0
(1,200,000)
(600,000)
(1,800,000)
380,000
180,000
380,000
1,000,000
100,000
Statement of RE: Beginning retained earnings
[E]
100,000
1,000,000
Net income
380,000
180,000
Dividends
(140,000)
(50,000)
380,000
Ending retained earnings
1,240,000
230,000
1,240,000
Cash
240,000
100,000
340,000
Accounts receivable
400,000
360,000
760,000
Inventory
620,000
430,000
1,050,000
Equity investment
730,000
50,000
[C]
(140,000)
Balance sheet: Assets
PPE, net
1,700,000
130,000
[C]
600,000
[E]
840,000
0
2,540,000
Patent
0
Goodwill
0 3,690,000
1,730,000
4,690,000
Accounts payable
250,000
160,000
410,000
Accrued liabilities
300,000
240,000
540,000
-
600,000
600,000
500,000
200,000
[E]
200,000
500,000
APIC
1,400,000
300,000
[E]
300,000
1,400,000
Retained earnings
1,240,000
230,000
3,690,000
1,730,000
Liabilities and SE
Long-term liabilities Common stock
Solutions Manual, Chapter 3
1,240,000 780,000
780,000
4,690,000
©Cambridge Business Publishers, 2020 3-21
47.
a. Equity investment Common stock APIC
1,000,000 20,000 980,000
(to record the acquisition)
b. [ADJ] BOY Equity Investment Beginning retained earnings (P) (to correct beginning retained earnings of the parent for cost method accounting for all period prior to the beginning of the current period. The acquisition occurred at the beginning of the current period, so it is not necessary in this problem.) [C]
[E]
0 0
Investment income (P) Dividends (S) (to eliminate all investment accounting recorded by the parent during the year)
60,000
Common stock (S) @ BOY APIC (S) @ BOY Retained earnings (S) @ BOY Equity Investment (P) @ BOY (to eliminate the portion of the investment account related to the book value of the subsidiary's Stockholders' Equity @ BOY)
160,000 200,000 640,000
[A]
No Accounting Acquisition Premium
[D]
(AAP) in problem
[I]
No intercompany items in problem
©Cambridge Business Publishers, 2020 3-22
60,000
1,000,000
Advanced Accounting, 4th Edition
47.
c. Income Statement
Parent
Subsidiary
Dr
Sales
3,400,000
1,600,000
5,000,000
Cost of goods sold
(1,560,000)
(900,000)
(2,460,000)
Gross profit
1,840,000
700,000
2,540,000
Consolidated
Investment income
60,000
Operating expenses
(1,300,000)
(500,000)
(1,800,000)
600,000
200,000
740,000
Beginning retained earnings
900,000
640,000
Net income
600,000
200,000
Dividends
(250,000)
(60,000)
Ending retained earnings
1,250,000
780,000
1,390,000
Cash
350,000
200,000
550,000
Accounts receivable
550,000
500,000
1,050,000
Inventory
700,000
660,000
1,360,000
Net income
[C]
Cr
60,000
0
Statement of RE: [E]
640,000
900,000 740,000 60,000
[C]
(250,000)
Balance sheet: Assets
Equity investment
1,000,000
PPE, net
1,200,000
1,000,000
900,000
[E]
0
2,100,000
Patent
0
Goodwill
0 3,800,000
2,260,000
5,060,000
Accounts payable
200,000
120,000
320,000
Accrued liabilities
650,000
300,000
950,000
Liabilities and SE
Long-term liabilities
-
700,000
600,000
160,000
[E]
160,000
600,000
APIC
1,100,000
200,000
[E]
200,000
1,100,000
Retained earnings
1,250,000
780,000
3,800,000
2,260,000
Common stock
700,000
1,390,000 1,060,000
1,060,000
5,060,000
d. It is zero because the [ADJ] entry corrects the beginning retained earnings of the parent for all accumulated years of cost method accounting for periods prior to the current one. Because the acquisition occurred at the beginning of the current year, there are prior periods prior to the beginning of the current one.
Solutions Manual, Chapter 3
©Cambridge Business Publishers, 2020 3-23
48.
a. Equity investment Common stock APIC (to record the acquisition)
1,770,000 59,000 1,711,000
b. Subsidiary net income Depreciation / amortization Equity income
$200,000 (50,000) $150,000
Beginning Equity Investment Equity Income Dividends Ending Equity Investment
$1,770,000 150,000 (60,000) $1,860,000
c.
d. [C] Equity income (P) Dividends (S) Equity Investment (P)
150,000 60,000 90,000
(to eliminate all changes in the Equity Investment account, leaving only beginning balance in the account)
[E] Common stock (S) @ BOY APIC (S) @ BOY Retained earnings (S) @ BOY Equity investment (P) @ BOY
150,000 200,000 800,000 1,150,000
(to eliminate the portion of the investment account related to the book value of the subsidiary's Stockholders' Equity @ BOY)
[A] PPE, net (S) @ BOY Patent (S) @ BOY Goodwill (S) @ BOY Equity investment (P) @ BOY
120,000 320,000 180,000 620,000
(to assign the remaining Equity Investment account (i.e., unamortized BOY AAP) to appropriate asset & liability accounts)
[D] Operating expenses (S) PPE, net (S) Patent (S)
50,000 10,000 40,000
(depreciates/amortizes AAP so that income statement includes the activity and the balance sheet accounts include ending balances in appropriate accounts)
[I]
No intercompany items in problem
©Cambridge Business Publishers, 2020 3-24
Advanced Accounting, 4th Edition
48.
e. Consolidation Entries Parent
Subsidiary
Dr
Cr
Consolidated
5,500,000
1,600,000
7,100,000
Income statement Sales Cost of goods sold
(3,800,000)
(950,000)
(4,750,000)
Gross profit
1,700,000
650,000
2,350,000
Equity income
150,000
Operating expenses Net income
[C]
150,000
0
[D]
50,000
(1,500,000)
(1,000,000)
(450,000)
850,000
200,000
2,800,000
800,000
850,000
200,000
850,000 (160,000)
850,000
Statement of retained earnings Beginning retained earnings Net income
[E]
2,800,000
800,000
Dividends
(160,000)
(60,000)
Ending retained earnings
3,490,000
940,000
[C]
60,000
300,000
120,000
420,000
3,490,000
Balance sheet Assets Cash Accounts receivable
700,000
360,000
1,060,000
Inventory
940,000
600,000
1,540,000
Equity investment
1,860,000
[C]
90,000
0
[E] 1,150,000 [A] 620,000 [A]
120,000
[D]
10,000
4,430,000
Patent
[A]
320,000
[D]
40,000
280,000
Goodwill
[A]
180,000
PPE, net
3,400,000
920,000
180,000
7,200,000
2,000,000
7,910,000
Accounts payable
220,000
100,000
320,000
Accrued liabilities
340,000
180,000
520,000
Long-term liabilities
450,000
430,000
880,000
Common stock
600,000
150,000
Liabilities and SE
APIC
2,100,000
200,000
Retained earnings
3,490,000
940,000
7,200,000
2,000,000
[E] [E]
150,000
600,000
200,000
2,100,000 3,490,000
1,970,000
1,970,000
7,910,000
f. We recognized the additional PPE assets, the Patent asset, and the Goodwill asset in the consolidation process. These assets were included in the Equity Investment account on the parent’s balance sheet and are now reported explicitly on the consolidated balance sheet.
Solutions Manual, Chapter 3
©Cambridge Business Publishers, 2020 3-25