Hoyle Ch3 Solutions

Chapter 03 - Consolidations—Subsequent to the Date of Acquisition

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Answers to Discussion Questions

How Does a Company Really Decide which Investment Method to Apply?

Students can come up with literally dozens of factors that should be considered by Pilgrim in making the decision as to the method of accounting for its subsidiary, Crestwood Corporation. The following is simply a partial list of possible points to consider.

Use of the information. If Pilgrim does not monitor its own income levels closely, applying the equity method would seem to be a waste of time and energy. A company must plan to use the additional data before the task of accumulation becomes worthwhile.

Size of the subsidiary. If the subsidiary is large in comparison to Pilgrim, the effort required of the equity method may be important. Income levels would probably be significant. However, if the subsidiary is actually quite small in relation to the parent, the impact might not be material enough to warrant the extra effort.

Size of dividend payments. If Crestwood pays out most of its earnings each period as dividends, that figure will approximate equity income. Little additional information would be accrued by applying the equity method. In contrast, if dividends are small or not paid on a regular basis, a Dividend Income balance might vastly understate the profits to be recognized by the business combination.

Amount of excess amortizations. If Pilgrim has paid a significant amount in excess of book value so that annual amortization charges are quite high, use of the equity method might be preferred to show the effect of this expense each month (or whenever internal reporting is made). In this case, waiting until the end of the year and recording all of the expense at one time through a worksheet entry might not be the best way to reflect the impact of the expense.

Amount of intercompany transactions. As with amortization, the volume of transfers can be an important element in deciding which accounting method to use. If few intercompany sales are made, monitoring the subsidiary through the application of the equity method is less essential. Conversely, if the amount of these transactions IS significant, the added data can be helpful to company administrators evaluating operations.

Sophistication of accounting systems. If Pilgrim and Crestwood both have advanced accounting systems, application of the equity method may be relatively simple. Unfortunately, if these systems are primitive, the cost and effort necessary to apply the equity method may outweigh any potential benefits.

The timeliness and accuracy of income figures generated by Crestwood. If the subsidiary reports operating results on a regular basis (such as weekly or monthly) and these figures prove to be reliable, equity totals recorded by Pilgrim may serve as valuable information to the parent. However, if Crestwood's reports are slow and often require later adjustment, Pilgrim's use of the equity method will provide only questionable results.


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Answers to Questions

1. a. CCES Corp., for its own recordkeeping, may apply the equity method to the investment in Schmaling. Under this approach, the parent's records parallel the activities of the subsidiary. The parent accrues income as it is earned by the subsidiary. Dividends paid by Schmaling reduce its book value; therefore, the CCES reduces the investment account. In addition, any excess amortization expense associated with the allocation of CCES's purchase price is recognized through a periodic adjustment. By applying the equity method, both the parent’s income and investment balances accurately reflect consolidated totals. The equity method is especially helpful in monitoring the income of the business combination. This method can be, however, rather difficult to apply and a time-consuming process.

b. The initial value method. The initial value method can also be utilized by CCES Corporation. Any dividends received are recognized as income but no other investment entries are made. Thus, the initial value method is easy to apply. However, the resulting account balances of the parent may not provide a reasonable representation of the totals that result from consolidating the two companies.

c. The partial equity method combines the advantages of the previous two techniques. Income is accrued as earned by the subsidiary as under the equity method. Similarly, dividends reduce the investment account. However, no other entries are recorded; more specifically, amortization is not recognized by the parent. The method is, therefore, easier to apply than the equity method but the subsidiary's individual totals will still frequently approximate consolidated balances.

2. a. The consolidated total for equipment is made up of the sum of Maguire’s book value, Williams’ book value, and any unamortized excess acquisition-date fair value over book value attributable to Williams’ equipment.

b. Although an Investment in Williams account is appropriately maintained by the parent, from a consolidation perspective the balance is intercompany in nature. Thus, the entire amount is eliminated in arriving at consolidated financial statements.

c. Only dividends paid to outside parties are included in consolidated statements. Because Maguire owns 100 percent of Williams, all of the subsidiary's dividends are intercompany. Consequently, only the dividends paid by the parent company will be reported in the financial statements for this business combination.

d. Any acquisition-date goodwill must still be reported for consolidation purposes. Reductions to goodwill are made if goodwill is determined to be impaired.

e. Unless intercompany revenues have been recorded, consolidation is achieved in subsequent periods by adding the two book values together.

f. Consolidated expenses are determined by combining the parent's and subsidiary amounts and then including any amortization expense associated with the purchase price. As will be discussed in detail in Chapter Five, intercompany expenses can also be present which require elimination in arriving at consolidated figures.

g. Only the parent’s common stock outstanding is included in consolidated totals.

h. The net income for a business combination is calculated as the difference between consolidated revenues and consolidated expenses.


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3. Under the equity method, the parent accrues subsidiary earnings and amortization expense (associated with the acquisition price in a purchase) in the same manner as in the consolidation process. The equity method parallels consolidation. Thus, the parent’s net income and retained earnings each year will equal the consolidated totals.

4. In the consolidation process, excess amortizations must be recorded annually for any portion of the purchase price that is allocated to specific accounts (other than land or to goodwill). Although this expense can be simulated in total on the parent's books by an equity method entry, the actual amortization of each allocated fair value adjustment is appropriate for consolidation. Hence, the effect of the parent's equity method amortization entry is removed as part of Entry I so that the amortization of specific accounts (e.g., depreciation) can be recorded (in consolidation Entry E).

5. When the initial value method is applied by the parent company, no accrual is recorded to reflect the subsidiary's change in book value during the years following acquisition. Furthermore, recognition of excess amortizations relating to the acquisition price is also omitted by the parent. The partial equity method, in contrast, records the subsidiary’s book value increases and decreases but not amortizations. Consequently, for both of these methods, a technique must be established within the consolidation process to record the omitted figures. Entry *C simply brings the parent's records (more specifically, the beginning retained earnings balance and the investment account) up-to-date as of the first day of the current year. If the initial value method has been applied by the acquiring company, any changes in the subsidiary's book value in previous years must be recognized on the worksheet along with the appropriate amount of amortization expense. For the partial equity method, only the amortization relating to these prior years needs to be recognized.

No similar entry is needed if the equity method has been applied; changes in the subsidiary's book value as well as excess amortization expense will be recorded each year by the parent. Thus, under the equity method, the parent's investment and beginning retained earnings balances are both correctly established without further adjustment.

6. Lambert's loan payable and the receivable held by Jenkins are intercompany accounts. As such, the reciprocal balances should be offset in the consolidation process. The $100,000 is not a debt to or a receivable from an unrelated (or outside) party and should, therefore, not be reported in consolidated financial statements. Additionally any interest income/expense recognized on this loan is also intercompany in nature and must likewise be eliminated.

7. Because Benns applies the equity method, the $920,000 is composed of four balances:

a. The original consideration transferred by the parent; b. The annual accruals made by Benns to recognize income as it is earned by the

subsidiary; c. The reductions that are created by the subsidiary's payment of dividends; d. The periodic amortization recognized by Benns in connection with the allocations

identified with its purchase price.

8. The $100,000 attributed to goodwill is reported at its original amount unless a portion of goodwill is impaired or a unit of the business where goodwill resides is sold.


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9. A parent should consider recognizing an impairment loss for goodwill associated with a purchased subsidiary when, at the reporting unit level, the fair value is less than its carrying amount. Goodwill is reduced when its carrying value is less than its fair value. To compute fair value for goodwill, its implied value is calculated by subtracting the fair values of the reporting unit’s identifiable net assets from its total fair value. The impairment is recognized as a loss from continuing operations.

10. The acquisition-date fair value of the contingent payment is part of the consideration transferred by Reimers to acquire Rollins and thus is part of the overall fair value assigned to the acquisition. If the contingency is a liability (to be settled in cash or other assets) then the liability is adjusted to fair value through time. If the contingency is a component of equity (e.g., to be settled by the parent issuing equity shares), then the equity instrument is not adjusted to fair value over time.

11. At present, the Securities and Exchange Commission requires the use of push-down accounting for the separate financial statements of a subsidiary where no substantial outside ownership exists. Thus, if Company A owns all of Company B, the push-down method of accounting is appropriate for the separately issued statements of Company B. The SEC normally requires push-down accounting where 95 percent of a subsidiary is acquired and the company has no outstanding public debt or preferred stock.

Push-down accounting may be required if 80-95 percent of the outstanding voting stock is purchased. Push-down accounting is justified in that the consideration transferred by provides the valuation basis for the subsidiary in consolidated reports. For example, if a piece of land costs Company B $10,000 but Company A pays $13,000 for the land when acquiring Company B, the land has a basis to the current owners of B of $13,000. If B's financial records had been united with A at the time of the acquisition, the land would have been reported at $13,000. Thus, leaving the $10,000 figure simply because separate incorporation is maintained is viewed, by proponents of push-down accounting, as unjustified.

12. When push-down accounting is applied, the subsidiary adjusts the book value of its assets and liabilities based on the acquisition-date fair value allocations. The subsidiary then recognizes eriodic amortization expense on those allocations with definite lives. Therefore, the income recorded by the subsidiary represents its impact on consolidated earnings.

The parent uses no special procedures when push-down accounting is being applied. However, if the equity method is in use, amortization need not be recognized by the parent since that expense is included in the figure reported by the subsidiary.

13. Push-down accounting has become popular for the parent's internal reporting purposes for two reasons. First, this method simplifies the consolidation process each year. If acquisition-date fair value allocations and subsequent amortizations are recorded by the subsidiary, they do not need to be repeated each year on a consolidation worksheet. Second, when the subsidiary records amortization, it provides a good representation of the impact that the acquisition has on the consolidated earnings. For example, if the subsidiary earns $100,000 each year but annual amortization is $80,000, the acquisition is only adding $20,000 to consolidated income each year rather than the $100,000 that is reported by the subsidiary in the absence of push-down accounting.


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Answers to Problems

1. A

2. B

3. A

4. D Willkom’s equipment book value —12/31/12....................... $210,000 Szabo’s equipment book value —12/31/12 .......................... 140,000 Original purchase price allocation to Szabo's equipment ($300,000 – $200,000) ........................................................... 100,000 Amortization of allocation ($100,000 ÷ 10 years for 3 years) ................................... (30,000) Consolidated equipment ...................................................... $420,000 5. A 6. B 7. D 8. B 9. B 10. C 11. C The $60,000 excess acquisition -date fair value allocation to equipment is

"pushed -down" to the subsidiary and increases its balance from $330,000 to $390,000. The consolidated balance is $810,000 ($420,000 plus $390,000).

12. (35 Minutes) (Determine consolidated retained earnings when parent uses

various accounting methods. Determine Entry *C for each of these methods ) a. CONSOLIDATED RETAINED EARNINGS

EQUITY METHOD Herbert (parent) balance —1/1/11 .................................. $400,000 Herbert income —2011 ................................................... 40,000 Herbert dividends —2011 (subsidiary dividends are intercompany and, thus, eliminated) ....................... (10,000) Rambis income —2011 (not included in parent's income) 20,000 Amortization —2011 ........................................................ (12,000) Herbert income —2012 ................................................... 50,000 Herbert dividends —2012 ................................................ (10,000) Rambis income —2012 ................................................... 30,000 Amortization —2012 ....................................................... (12,000)


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Consolida ted Retained Earnings, 12/31/12 ................... $496,000

PARTIAL EQUITY METHOD AND INITIAL VALUE METHOD Consolidated retained earnings are the same regardless of the method in use: the beginning balance plus the income of the parent less the dividends of the parent plu s the income of the subsidiary less amortization expense. Thus, consolidated retained earnings on December 31, 2012 are $496,000 as computed above.

b. Investment in Rambis —equity method Rambis fair value 1/1/11 ............................................................. $574,000 Rambis income 2011 .................................................................. 20,000 Rambis dividends 2011 .............................................................. (5,000) Herbert’s 2011 excess fair over book value amortization ...... (12,000) Investment account balance 1/1/12 .......................................... $577,000 Investment in Rambis —partial equity method Rambis fair value 1/1/11 ............................................................. $574,000 Rambis income 20 11 .................................................................. 20,000 Rambis dividends 2011 .............................................................. (5,000) Investment account balance 1/1/12 .......................................... $589,000 Investment in Rambis —Initial value method Rambis fair value 1/1/11 ............................................................. $574,000 Investment account balance 1/1/12 .......................................... $574,000 12. (continued)

c. ENTRY *C

EQUITY METHOD No entry is needed to convert the past figures to the equity method since that method has already been applied. PARTIAL EQUITY METHOD Amortization for the prior years (only 2011 in this case) has not been recorded and must be brought into the consolidation through worksheet entry *C: ENTRY *C Retained Earnings, 1/1/12 (Parent) .................... 12,000 Investment in Rambis .................................... 12,000 (To record 2011 amortization in consolidated figures. Expense was omitted because of application of partial equity method.) INITIAL VALUE METHOD


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Amortization for the prior years (only 2011 in this case) has not been recorded and must be brought into the consolidation through worksheet entry *C. In addition, only dividend income has been recorded by the parent ($5,000 in 2011). In this prior year, Rambis reported net income of $20,000. Thus, the parent has not recorded the $15,000 income in excess of dividends. That amount must also be included in the consolidation through entry *C: ENTRY *C Investment in Rambis ......................................... 3,000 Retain ed Earnings, 1/1/12 (Parent) ............... 3,000 (To record 2011 unrecognized subsidiary earnings as part of the parent’s retained earnings. $15,000 income of subsidiary was not recorded by parent (income in excess of dividends). Amortization expense of $12,000 was not recorded under the initial value method. Note that *C adjustments bring the parent’s January 1, 2012 Retained Earnings balance equal to that of the equity method.

13. (30 Minutes) (A variety of questions on equity method, initial value method,

and partial equity method. ) a. An allocation of the acquisition price (based on the fair value of the

shares Issued) must be made first. Acquisition fair value (consideration paid by Haynes) $135,000 Book value equivalency ................................................. (100,000) Excess of Turner fair value over book value ............... $35,000

Excess fair value assigned to specific Annual Excess accounts based on fair value Life Amortizations Equipment ......................... $5,000 5 yrs. $1,000 Customer List ...................... 30,000 10 yrs. 3,000 $4,000 Acquisition fair value ...................................................... $135,000 2011 Income accrual ...................................................... 110,000 2011 Dividends paid by Turner ..................................... (50,000) 2011 Amortizations (above) ........................................... (4,000) 2012 Income accrual ...................................................... 130,000 2012 Dividends paid by Turner ..................................... (40,000) 2012 Amortizations ........................................................ (4,000) Investment i n Turner account balance ......................... $277,000

b. Net income of Haynes .................................................... $240,000 Net Income of Turner ..................................................... 130,000 Depreciation expense ..................................................... (1,000)


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Amortization expense ..................................................... (3,000) Consolidated net income 2012 ................................ $366,000 c. Equipment balance Haynes ........................................... $500,000 Equipment balance Turner ............................................ 300,000 Allocation based on fair value (above) ......................... 5,000 Depreciation for 2011 -2012 ............................................ (2,000) Consolidated equipment —December 31, 2012 ............. $803,000 Parent's choice of an investment method has no impact on consoli dated

totals. 13. (continued)

d. If the initial value method was applied during 2011, the parent would have recorded dividend income of $50,000 rather than $110,000 (as equity income). Income is, therefore, understated by $60,000. In addition, amortization expense of $4,000 was not recorded. Thus, the January 1, 2012, retained earnings is understated by $56,000 ($60,000 – $4,000). An Entry *C is necessary on the worksheet to correct this equity figure:

Investment in Turner ........................................... 56,000 Retained Earnings, 1/1/12 (Haynes) ............. 56,000

If the partial equity method was applied during 2011, the parent would have failed to record amortization expense of $4,000. Retained earnings are overstated by $4,000 and are corrected through Entry *C:

Retained Earnings, 1/1/ 12 (Haynes) ................... 4,000 Investment in Turner ..................................... 4,000

If the equity method was applied during 2011, the parent's retained earnings are the same as the consolidated figure so that no adjustment is necessary.

14. (20 minutes) (Record a merger combination wi th subsequent testing for

goodwill impairment). a. In accounting for the combination, the total fair value of Beltran (consideration

transferred) is allocated to each identifiable asset acquired and liability assumed with any remaining excess as goodwill .

Cash paid $450,000 Fair value of shares issued 1,248,000


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Fair value transferred $1,698,000 Fair value transferred (above) $1,698,000 Fair value of net assets acquired and liabilities assumed Goodwill recognized in the combination $400,000

1,298,000

Entry by Francisco to record assets acquired and liabilities assumed in t he combination with Beltran :

Cash 75,000 Receivables 193,000 Inventory 281,000 Patents 525,000 Customer relationships 500,000 Equipment 295,000 Goodwill 400,000 Accounts payable 121,000 Long -term liabilities 450,000 Cash 450,000 Common stock (Francisco Co., par value) 104,000 Additional paid -in capital 1,144,000 b. Step one in goodwill impairment test: Fair value of reporting unit as a whole 1,425,000 Book value of reporting unit's net assets 1,585,000

Because the total fair value of the reporting unit is less than its carrying value, a potential goodwill impairment loss exists, step two is performed:

Fair value of reporting unit as a whole $1,425,000 Fair values of reporting unit's net assets (excluding goodwill) Implied f air value of goodwill 100,000

1,325,000

Book value of goodwill Goodwill i mpairment loss $300,000

400,000

15. (20 minutes) (Goodwill impairment testing.)

a. Goodwill Impairment

Step 1 Fair value of reporting unit = $650 Carrying value of reporting unit = 780 Because fair value < carrying value, there is a potential goodwill impairment

loss.


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Step 2 Fair value of reporting unit $650 Fair value of net assets excluding goodwill Tangible assets $110 Recognized intangibles 230 Unrecognized intangibles 200 540 Implied value of goodwill 110 Carrying value of goodwill 500 Goodwill impairment loss $390 b. Tangible assets, net $80 Goodwill 110 Customer list -0- Patent -0- 16. (30 minutes) (Goodwill impairment and intangible assets.) Part a

Goodwill Impairment Test —Step 1 Total fair Carrying Potential goodwill value value impairment ? Sand Dollar $510,000 < $530,000 yes Salty Dog 580,000 < 610,000 yes Baytowne 560,000 > 280,000 no Part b

Goodwill Impairment Test —Step 2 (Sand Dollar and Salty Dog only)

Sand Dollar —total fair value $510,000 Fair values of identifiable net as sets Tangible assets $190,000 Trademark 150,000 Customer list 100,000 Liabilities (30,000) 410,000 Implied value of goodwill 100,000 Carrying value of goodwill 120,000 Impairment loss $20,000

Salty Dog —total fair value $580,000 Fair values of identifiable net assets Tangible assets $200,000 Unpatented technology 125,000 Licenses 100,000 425,000


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Implied value of goodwill 155,000 Carrying value of goodwill 150,000 No impairment —implied value > carry value -0-

Part c No changes in tangible assets or identifiable intangibles are reported based on goodwill impairment testing. The sole purpose of the valuation exercise is to estimate an implied value for goodwill. Destin will report a goodwill impairment loss of $20,000, which will reduce the amount of goodwill allocated to Sand Dollar. However, because the fair value of Sand Dollar’s trademarks is less than its carrying amount, the account should be subjected to a separate impairment testing procedure to see if the carrying value is “recoverable” in future estimated cash flows.

17. (30 Minutes) (Consolidation entries for two years. Parent uses equity

method. ) Fair Value Allocation and Annual Amortization: Acquisition fair value (consideration transferred ) . $490,000 Book value (assets minus liabilities or total stockholders' equity) .................................................................. (400,000) Excess fair value over book value .......................... $90,000 Excess fair value assigned to specific accounts based on individual fair values Annual Excess Life Amortizat ions Land .................................... $10,000 -- -- Buildings ............................. 40,000 4 yrs. $10,000 Equipment ........................... (20,000) 5 yrs. (4,000) Total assigned to specific accounts ........................ 30,000 Goodwill .............................. 60,000 Indefinite -0- Total .................................... $90,000 $6,000 Consolidation En tries as of December 31, 2011 Entry S Common Stock —Abernethy ................................ 250,000 Additional Paid -in Capital ................................... 50,000 Retained Earnings —1/1/11 ................................. 100,000 Investment in Abernethy ............................... 400,000 (To eliminate stockholders' equity accounts of subsidiary) Entr y A


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Land ..................................................................... 10,000 Buildings .............................................................. 40,000 Goodwill ............................................................... 60,000 Equipment ...................................................... 20,000 Investment in Abernethy ............................... 90,000

(To recognize allocations attributed to fair value of specific accounts at acquisition date with residual fair value recognized as goo dwill).

Entry I Equity in Subsidiary Earnings ........................... 74,000 Investment in Abernethy ............................... 74,000 (To eliminate $80,000 income accrual for 2011 less $6,000 amortization recorded by parent using equity method) 17. (continued) Entry D Investment in Abernethy .................................... 10,000 Dividends Paid ............................................... 10,000 (To eliminate intercompany dividend transfers) Entry E Depreciation expense .......................................... 6,000 Equipment ............................................................. 4,000 Buildings ......................................................... 10,000 (To record current year amortization expense) Consolidation Entries as of December 31, 2012

Entry S Common Stock —Abernethy ............................... 250,000 Additional Paid -in Capital ................................... 50,000 Retained Earnings —1/1/12 .................................. 170,000 Investment in Abernethy ............................... 470,000

(To eliminate beginning stockholders' equity of subsidiary —the Retained Earnings a ccount has been adjusted for 2011 income and dividends. Entry *C is not needed because equity method was applied.)

Entry A Land ..................................................................... 10,000 Buildings .............................................................. 30,000 Goodwill ............................................................... 60,000 Equipment ...................................................... 16,000 Investment in Abernethy ............................... 84,000


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(To recognize allocations relating to investment —balances shown here are as of beginning of current year [original allocation less excess amortizations for the prior period])

Entry I Equity in Subsidiary Earnings ........................... 104,000 Investment in Abernethy ............................... 104,000

(To eliminate $110,000 income accrual less $6,000 amortization recorded by parent during 2012 using equity method)

Entry D Investment in Abernethy .................................... 30,000 Dividends Paid ............................................... 30,000

(To eliminate intercompany dividend transfers) Entry E Same as Entr y E for 2011 18. (35 Minutes) (Consolidation entries for two years. Parent uses initial value

method. )

Purchase Price Allocation and Annual Excess Amortizations: Acquisition date value (consideration paid) ..... $500,000 Book value ........................................................... (400,000) Excess pr ice paid over book value .................... $100,000

Excess price paid assigned to specific Annual Excess accounts based on fair values Life Amortizations Equipment $20,000 5 yrs. $4,000 Long -term liabilities 30,000 4 yrs. 7,500 Goodwill $50,000 Indefinite -0- Total $100,000 $11,500 Consolidation Entries as of December 31, 2011 Entry S Common Stock —Abernethy .............................. 250,000 Additional Paid -in Capital .................................. 50,000 Retained Earnings —1/1/11 ................................ 100,000 Investment in Abernethy ............................... 400,000 (To eliminate stockholders' equity accounts of subsidiary) Entry A Equipment ........................................................... 20,000 Long -term Liabilities .......................................... 30,000 Goodwill .............................................................. 50,000 Investment in Abernethy .............................. 100,000

(To recognize allocations determined above in connection with acquisition -date fair values)


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Entry I Dividend Income ................................................ 10,000 Dividends Paid .............................................. 10,000

(To eliminate intercompany dividend payments recorded by parent as income)

Entry E Depreciation expense ........................................ 4,000 Interest expense .................................................. 7,500 Equipment ...................................................... 4,000 Long -term liabilities ....................................... 7,500 (To record 2011 amortization expense) 18. (continued) Consolidation Entries as of December 31, 2012 Entry *C Investment in Abernethy ................................... 58,500 Retained Earnings —1/1/12 (Chapman) ....... 58,500

(To convert parent company figures to equity method by recognizing subsidiary's increase in book value for prior year [$80,000 net income less $10,000 dividend payment] and excess amortizations for that period [$11,500])

Entry S Common Stock —Abernethy .............................. 250,000 Additional Paid -in Capital .................................. 50,000 Retained Earnings —1/1/12 ................................ 170,000 Investment in Abernethy .............................. 470,000

(To eliminate beginning of year stockholders' equity accounts of subsidiary. The retained earnings balance has been adjusted for 2011 income and dividends)

Entr y A Equipment ........................................................... 16,000 Long -term Liabilities .......................................... 22,500 Goodwill .............................................................. 50,000 Investment in Abernethy .............................. 88,500

(To recognize allocations relating to investment —balances shown here are as of the beginning of the current year [original allocation less excess amortizations for the prior period])

Entry I Dividend Income ................................................ 30,000 Dividends Paid ......................................... 30,000

(To eliminate intercompany dividend payments recorded by parent as income)

Entry E Same as Entry E for 2011


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19. (20 Minutes) (Consolidation e ntries for two years. Parent uses partial equity

method. ) Fair Value Allocation and Annual Excess Amortizations: Abernethy fair value (consideration paid) .............. $520,000 Book value ................................................................ (400,000) Excess fair value over book value (all goodwill) ... $120,000 Life assigned to goodwill ......................................... Indefinite Annual excess amortizations .................................. -0-

Consolidation Entries as of December 31, 2011 Entry S Common Stock —Abernethy ............................... 250,000 Additional Paid -in Capital ................................... 50,000 Retained Earnings —Abernethy —1/1/11 ............ 100,000 Investment in Abernethy ............................... 400,000 (To eliminate stockholders' equity accounts of subsidiary) Entry A Goodwill ............................................................... 120,000 Investment in Abernethy ............................... 120,000 (To recognize goodwill portion of the original acquisition fair value) Entry I Equit y in Earnings of Subsidiary ........................ 80,000 Investment in Abernethy ............................... 80,000

(To eliminate intercompany income accrual for the current year based on the parent's usage of the partial equity method)

Entry D Investment in Abernethy .................................... 10,000 Dividends Paid ............................................... 10,000 (To eliminate intercompany dividend transfers) Entry E —Not needed. Goodwill is not amortized. Consolidation Entries as of December 31, 2012 Entry *C —Not needed. Goodwill is not amortized. Entry S Common Stock —Abernethy ................................ 250,000 Additional Paid -in Capital —Abernethy .............. 50,000 Retained Earnings —Abernethy —1/1/12 ............ 170,000 Investment in Abernethy ............................... 470,000

19. (continued)


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(To eliminate beginning of year stockholders' equity accounts of subsidiary —the retained earnings balance has been adjusted for 2011 income and dividends.)

Entry A Goodwill ............................................................... 120,000 Investment in Abernethy ............................... 120,000

(To recognize original goodwill balance.) Entry I Equity in Earnings of Subsidiary ........................ 110,000 Investment in Abernethy ............................... 110,000

(To eliminate Intercompany Income accrual for the current year.) Entry D Investment in Abernethy .................................... 30,000 Dividends Paid ............................................... 30,000 (To eliminate Intercompany dividend transfers.) Equity E —not needed 20. (45 Minutes) (Variety of questions about the three methods of recording an

Investment in a subsidiary for internal reporting purposes. )

a. Purchase Price Allocation and Annual Amortization:

Clay’s acquisition -date fair value ............ $510,000 Book value (assets minus liabilities or stockholders' eq uity) ...................... 450,000 Fair value in excess of book value .......... 60,000 Annual Excess Allocation to equipment based on Life Amortizations difference between fair and book value .. 50,000 5 yrs. $10,000 Goodwill ..................................................... $10,000 indefinite -0- Total .......................................................... $10,000

EQUITY METHOD Investment Income —2011: Equity accrual (based on Clay's income) .................... $55,000 Amortization (above) ..................................................... (10,000) Investment income for 2011 ................................................ $45,000 20. (continued) Investment in Clay —December 31, 2011:


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Consideration transferred for Clay ............................... $510,000 2010:

Equity accrual (based on Clay's Income) ............... 55,000 Excess amortizations (above) ................................. (10,000) Dividends received ................................................... (5,000)

2011: Equity accrual (based on Clay's Income) ................ 60,000 Excess amortizations ............................................... (10,000) Dividends received ................................................... (8,000)

Total ................................................................................ $592,000 INITIAL VALUE METHOD Investment Income —2011: Dividend Income ........................................................... $8,000 Investment in Clay —December 31, 2011: Consideration transferred for Clay ............................... $510,000

b. The reported consolidated balances are not affected by the parent’s investment accounting method. Thus, consolidated expenses ($480,000 or $290,000 + $180,000 + amortizations of $10,000) are the same regardless of whether the equity method, the partial equity method, or the initial value method is applied by Adams.

c. The reported consolidated balances are not affected by the parent’s

investment accounting method. Thus, consolidated equipment ($970,000 or $520,000 + $420,000 + allocation of $50,000 – two years of excess depreciation totaling $20,000) is the same regardless of whether the equity method or the initial value method is applied by Adams.

d. Adams Retained Earnings —Equity Method Adams Retained Earnings —1/1/10 ..................................... $860,000 Adams income 2010 ............................................................. 125,000 2010 equity accrual for Clay income .................................. 55,000 2010 excess amortization .................................................... (10,000) Adams Retained Earnings —1/1/11 ..................................... $1,030,000 Adams Retained Earnings —Initial value method Adams Retained Earnings —1/1/10 ..................................... $860,000 Adams income 2010 ............................................................. 125,000 2010 dividend income from Clay ........................................ 5,000 Adams Retained Earnings —1/1/11 ..................................... $990,000

20. (continued)


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e. EQUITY METHOD—Entry *C is not utilized since parent's retained earnings balance is correct.

INITIAL VALUE METHOD —Entry *C is needed to record increase in subsidiary's book value ($55,000 income less 5,000 dividends) and amortization ($10,000) for prior year.

Investment in Clay .............................................. 40,000 Retained earnings, 1/1/11 (parent) ................ 40,000 f. Consolidated worksheet entry S for 2011: Common stock (Clay) .................................... 150,000 Retained earnings, 1/1/11 (Clay) .................... 350,000 Investment in Clay .................................... 500,000 g. Consolidated revenues (combined) .................. $640,000 Consolidated expenses (combined plus excess amortization) ..................................... (480,000) Consolidated net income .................................... $160,000

21. (15 Minutes) (Consolidated accounts one year after acquisition)

Stanza acquisition fair value ($10,000 in stock issue costs reduce additional paid -in capital) .................... $680,000 Book value of subsidiary (1/1/12 stockholders' equity balances) ..... (480,000) Fair value in excess of book value .......... $200,000 Excess fair value allocated to copyrights Life Amortizations based on fair value .............................. 120,000 6 yrs. $20,000 Goodwill ..................................................... $80,000 indefinite -0- Total ...................................................... $20,000 a. Consolidated copyright s Penske (book value) ...................................... $900,000 Stanza (book value) ....................................... 400,000 Allocation (above) .......................................... 120,000 Excess amortizations, 2012 .......................... (20,000) Total ........................................................... $1,400,000

21. (continued)

b. Consolidated net income, 2012 Revenues (add book values) ........................ $1,100,000 Expenses: Add book values ....................................... $700,000 Excess amortizations ............................... 20,000 720,000 Consolidated net income ............................... $380,000 c. Consolidated retained earnings, 12/31/12

Annual Excess


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Retained earnings 1/1/12 (Penske) ............... $600,000 Net income 2012 (above) ............................... 380,000 Dividends paid 2012 (Penske) ...................... (80,000) Total ........................................................... $900,000

Stanza's retained earnings balance as of January 1, 2011, is not

included because these operations occurred prior to the purchase. Stanza's dividends were paid to Penske and therefore are excluded because they are intercompany in nature.

d. Consolidated goodwill, 12/31/12 Allocation (above) .......................................... $80,000

22. (30 Minutes) (Consolidated balances three years after the date of

acquisition. Includes questions about parent's method of recor ding investment for internal reporting purposes. ) a. Acquisition -Date Fair Value Allocation and Amortization: Consideration transferred 1/1/11 ............. $600,000 Book value (given) .................................... (470,000) Annual Fair value in excess of book value ..... 130,000 Excess All ocation to equipment based on Life Amortizations difference in fair value and book value ............................................ 90,000 10 yrs. $9,000 Goodwill ..................................................... $40,000 indefinite -0- Total ...................................................... $9,000

CONSOLIDATED BALANCES

Depreciation expense = $659,000 (book values plus $9,000 excess depreciation)

Dividends Paid = $120,000 (parent balance only. Subsidiary's dividends are eliminated as intercompany transfer)

Revenues = $1,400,000 (add book values)

Equipment = $1,563,000 (add book values plus $90,000 allocation less three years of excess depreciation [$27,000])

22. (continued)

Buildings = $1,200,000 (add book values)

Goodwill = $40,000 (original residual allocation)

Common Stock = $900,000 (parent balance only) b. The parent's choice of an investment method has no impact on the

consolidated totals. The choice of an investment method only affects the internal reporting of the parent.


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c. The initial value method is used. The parent's Investment in Subsidiary

account still retains the original consideration transferred of $600,000. In addition, the Investment Income account equals the amount of dividends paid by the subsidiary.

d. If the partial equity method had been utilized, the investment income account would have shown an equity accrual of $100,000. If the equit y method had been applied, the Investment Income account would have included both the equity accrual of $100,000 and excess amortizations of $9,000 for a balance of $91,000.

e. Initial Value Method —Foxx’s Retained Earnings —1/1/13 Foxx’s 1/1/13 balance (i nitial value method was employed) $1,100,000 Partial Equity Method —Foxx’s Retained Earnings —1/1/13 Foxx’s 1/1/13 balance (initial value method) ..................... $1,100,000 2011 net equity accrual for Greenburg (90,000 – 20,000).. 70,000 2012 net equity accrual for Greenburg (100,000 – 20,000) 80,000 Foxx’s 1/1/13 Retained Earnings ........................................ $1,250,000

Equity Method —Foxx’s Retained Earnings —1/1/13 Foxx’s 1/1/13 balance (initial value method) ..................... $1,100,000 2011 net equity accrual for Greenburg (90,000 – 20,000).. 70,000 2011 excess fair over book value amortization ................. (9,000) 2012 net equity accrual for Greenburg (100,000 – 20,000) 80,000 2012 excess fair over book value amortization ................. (9,000) Foxx’s 1/1/13 Retained Earnings ........................................ $1,232,000

23. (50 Minutes) (Consolidated totals for an acquisition. Worksheet is

produced as a separate requirement. )

a. O’Brien acquisition -date fair value .................... $550,000 O’Brien book value ............................................. (350,000) Fair value in excess of book value .................... $200,000

Excess assigned to specific Ann ual accounts based on fair value Life Excess Amortizations Trademarks .............................. 100,000 indefinite -0- Customer relationships ........... 75,000 5 yrs. $15,000 Equipment ................................ (30,000) 10 yrs. (3,000) Goodwill ................................... 55,000 indefinite -0- Total .......................................... $200,000 $12,000

If the partial equity method were in use, the Income of O’Brien account would have had a balance of $222,000 (100% of O’Brien's reported income for the period). If the initial value method were in use, the Income of O’Brien account would have had a balance of $80,000 (100% of the dividends paid by O’Brien).


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The Income of O’Brien balance is an equity accrual of $222,000 (100% of O’Brien’s reported income) less excess amortizations of $12,000 ( as computed above). Thus, the equity method must be in use.

b. Students can develop consolidated figures conceptually, without relying on a

worksheet or consolidation entries. Thus, part b. asks students to determine independently each balance to be reported by the business combination. Revenues = $1,645,000 (the accounts of both companies combined)

Cost of Goods Sold = 528,000 (the accounts of both companies combined)

Amortization Expense = $40,000 (the accounts of both companies and the acquisition -related adjustment of $15,000)

Depreciation Expense = $142,000 (the accounts for both companies and the acquisition -related depreciation adjustment of $3,000)

Income of O’Brien = $0 (the balance reported by the parent is removed and replaced with the subsidi ary’s individual revenue and expense accounts)

Net Income = 935,000 (consolidated revenues less expenses)

Retained Earnings, 1/1 = $700,000 (only the parent's retained earnings figure is included)

Dividends Paid = $142,000 (the subsidiary's dividends were paid to the parent and, thus, as an intercompany transfer are eliminated)

Retained Earnings, 12/31 = $1,493,000 (the beginning balance for the parent plus consolidated net income less consolidated [parent] dividends)

23. (continued)

Cash = $290,000 (the accounts of both companies are added together)

Receivables = $281,000 (the accounts of both companies are combined)

Inventory = $310,000 (the accounts of both companies are combined)

Investment in O’Brien = $0 (the parent’s balance is removed and replaced with the subsidiary’s individual asset and liability accounts)

Trademarks = $634,000 (the accounts of both companies are added together plus the 100,000 fair value adjustment)

Customer relationships = $60,000 (the initial $75,000 fair value adjustment less $15,000 amortization expense)

Equipment = $1,170,000 (both company’s balances less the $30,000 fair value adjustment net of $3,000 in depreciation expense reduction )

Goodwill = $55,000 (the original allocation)

Total Assets = $2,800,000 (summation of consolidated balances)


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Liabilities = $907,000 (the accounts of both companies are combined)

Common Stock = $400,000 (parent balance only)

Retained Earnings, 12/31 = $1,493,000 (computed above)

Total Liabilities and Equities = 2,800,000 (summation of consoli dated balances)


3-23

23. (Continued) c. PATRICK COMPANY AND CONSOLIDATED SUBSIDIARY

Consolidation Worksheet For Year Ending December 31

Consolidation Entries Consolidated Accounts Patrick O’Brien Debit Credit Totals Revenues (1,125,000) (520,000) (1,645,000)

Cost of goods sold 300,000 228,000 528,000 Depreciation expense 75,000 70,000 (E) 3,000 142,000 Amortization expense 25,000 -0- (E) 15,000 40,000

Income of O’Brien (210,000) -0- (I) 210,000 -0- Net income (935,000) (222,000) (935,000)

Retained earnings, 1/1 (700,000) (250,000) (S)250,000 (700,000) Net income (above) (935,000) (222,000) (935,000) Dividends paid 142,000 80,000 (D) 80,000 142,000 Retained earnings, 12/31 (1,493,000) (392,000) (1,493,000)

Cash 185,000 105,000 290,000 Receivables 225,000 56,000 281,000 Inventory 175,000 135,000 310,000 Investment in O’Brien 680,000 (D) 80,000 (S) 350,000 (A) 200,000 -0- (I) 210,000 Trademarks 474,000 60,000 (A) 100,000 634,000 Customer relationships -0- -0- (A) 75,000 (E) 15,000 60,000 Equipment (net) 925,000 272,000 (E) 3,000 (A) 30,000 1,170,000 Goodwill -0- -0- (A) 55,000 55,000 Total assets 2,664,000 628,000 2,800,000

Liabilities (771,000) (136,000) (907,000) Common stock (400,000) (100,000) (S)100,000 (400,000) Retained earnings (above) (1,493,000) (392,000) (1,493,000)) Total liabilities and equity (2,664,000) (628,000) (2,800,000)


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24. (60 Minutes) (Consolidation worksheet five years after acquisition with parent using initial value method. Effects of using equity method also included )

Acquisition -Date Fair Value Allocation an d Annual Amortization: a. Aaron fair value (stock exchanged at fair value) ....................................... $470,000 Book value of subsidiary ....................... (360,000) Excess fair value over book value ........ $110,000 Excess assigned to specific accounts based on fair values Annual Excess

Life Amortizations Royalty agreements $60,000 6 yrs. $10,000 Trademark 50,000 10 yrs. 5,000 Total $110,000 $15,000

The parent company is apparently applying the initial value method: only dividend income is recognized during the cur rent year and the investment account retains its original $470,000 balance. Therefore, both the subsidiary's change in retained earnings during 2009 –2012 as well as the amortization for that period must be brought into the consolidation. Aaron' retained e arnings January 1, 2013 ......................... $490,000 Retained earnings at date of purchase ............................. (230,000) Increase since date of purchase ........................................ $260,000 Excess amortization expenses ($15,000 x 4 years) .......... (60,000) Conversion to equity method for years prior to 2013 (Entry *C) ................................................................... $200,000 Explanation of Consolidation Entries Found on Worksheet

Entry*C: Converts 1/1/13 figures from initial value method to equity method as per computation above.

Entry S: Eliminates stockholders' equity accounts of subsidiary as of the beginning of current year.

Entry A: Recognizes allocations to royalty agreements and trademark. This entry establishes unamortized balances as of the beginning of the current year.

Entry I: Eliminates intercompany dividends.

Entry E: Records excess amortization expenses for the current year. See next page for worksheet.


3-25

24. a. (continued) MICHAEL COMPANY AND CONSOLIDATED SUBSIDIARY

Consolidation Worksheet For Year Ending December 31, 2013

Consolidation Entries Consolidated Acc ounts Michael Aaron Debit Credit Totals Revenues $(610,000) $(370,000) $(980,000)

Cost of goods sold 270,000 140,000 410,000 Amortization expense 115,000 80,000 (E) 15,000 210,000 Dividend income (5,000) -0- (I) 5,000 -0-

Net income $(230,000) $(150,000) $(360,000) Retained earnings 1/1 $(880,000) (*C) 200,000 $(1,080,000) (490,000) (S) 490,000 -0- Net income (above) (230,000) (150,000) (360,000) Dividends paid 90,000 5,000 (I) 5,000 90,000 Retained earnings 12/31 $(1,020,000) $(635,000) $(1,350,000) Cash $110,000 $15,000 $125,000 Receivables 380,000 220,000 600,000 Inventory 560,000 280,000 840,000 Investmen t in Aaron Co. 470,000 -0- (*C) 200,000 (S) 620,000 -0- (A) 50,000 Copyrights 460,000 340,000 800,000 Royalty agreements 920,000 380,000 (A) 20,000 (E) 10,000 1,310,000 Trademark -0- -0- (A) 30,000 (E) 5,000 25,000 Total assets $2,900,000 $1,235,000 $3,700,000 Liabilities $(780,000) $(470,000) $(1,250,000) Preferred stock (300,000) -0- (300,000) Common stock (500,000) (100,000) (S) 100,000 (500,000) Additional paid -in capital (300,000) (30,000) (S) 30,000 (300,000) Retained earnings 12/31 (1,020,000) (635,000) (1,350,000) Total liabilities and equity $(2,900,000) $(1,235,000) $(3,700,000) Parentheses indicate a credit balance.


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24. (con tinued)

b. If the equity method had been applied by Michael, three figures on that company's financial records would be different: Equity in Earnings of Aaron, Retained Earnings —1/1/13, and Investment in Aaron Co.

Equity in Earnings of Aaron: $135,000 (th e parent would accrue 100% of Aaron's $150,000 income but must also recognize $15,000 in amortization expense.)

Retained Earnings, 1/1/13: $1,080,000 (increases by $200,000 —the parent would have recognized the $260,000 increment in the subsidiary's book va lue during previous years as well as $60,000 in excess amortization expenses for these same four years [see Part a.])

Investment in Aaron: $800,000 (increases by $330,000 —the parent would have recognized the $260,000 increment in the subsidiary's book valu e during previous years as well as $60,000 in excess amortization expenses for these same four years [see Part a.]. In the current year, income of $135,000 would have been recognized [see above] along with a reduction of $5,000 for dividends received).

c. No Entry *C is needed on the worksheet if the equity method is applied. Both the investment account as well as beginning retained earnings would be stated appropriately.

Entry I would have been used to eliminate the $135,000 Equity in Earnings of Aaron fr om the parent's income statement and from the Investment in Aaron Co. account.

Entry D would eliminate the $5,000 current year dividend from Divide nds Paid and the Investment in Aaron account balances.

d. Consolidated figures are not affected by the invest ment method used by the parent. The parent company balances would differ and changes would be required in the worksheet entries. However, the figures to be reported do not depend on the parent's selection of a method.

25. (65 Minutes) (Consolidated total s and worksheet five years after

acquisition. Parent uses equity method. Includes goodwill impairment.)

a. Acquisition -date fair value allocations (given) Life Excess Amortizations

Land $90,000 -- -- Equipment 50,000 10 yrs. $5,000 Goodw ill 60,000 indefinite -0- Total $200,000 $5,000


3-27

Because Giant uses the equity method, the $135,000 "Equity in Income of Small" reflects a $140,000 equity accrual (100% of Small’s reported earnings) less $5,000 in amortization expense c omputed above.

b. Revenues = $1,535,000 (both balances are added together)

Cost of Goods Sold = $640,000 (both balances are added)

Depreciation Expense = $307,000 (both balances are added along with excess equipment depreciation)

Equity in Income of Smal l = $0 (the parent's income balance is removed and replaced with Small's individual revenue and expense accounts)

Net Income = $588,000 (consolidated expenses are subtracted from consolidated revenues)

Retained Earnings, 1/1/13 = $1,417,000 (the parent’s b alance)

Dividends Paid = $310,000 (the parent number alone because the subsidiary's dividends are intercompany, paid to Giant)

Retained Earnings, 12/31/13 = $1,695,000 (the parent’s balance at beginning of the year plus consolidated net income less consol idated dividends paid)

Current Assets = $706,000 (both book balances are added together while the $10,000 intercompany receivable is eliminated)

Investment in Small = $0 (the parent's asset is removed so that Small's individual asset and liability accounts can be brought into the consolidation)

Land = $695,000 (both book balances are added together along with the purchase price allocation of $90,000)

Buildings = $723,000 (both book balances are added together)

Equipment = $959,000 (both book balances are added plus the unamortized portion of the purchase price allocation [$50,000 less $25,000 after 5 years of excess depreciation])

25. b. (continued)

Goodwill = $60,000 (represents the original price allocation)

Total Assets = $3,143,000 (summation of all consolidated assets)

Liabilities = $1,198,000 (both balances are added together while the $10,000 intercompany payable is eliminated)

Common Stock = $250,000 (parent balance only)

Retained Earnings, 12/31/13 = $1,695,000 (see above)


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Total Liabilities and Equity = $3,143,000 (summation of all consolidated liabilities and equity)

a. Worksheet is presented on following page. b. If all goodwill from the Small investment was determined to be impaired,

Giant would make the following journal entry on its books:

Goodwill impairment loss 60,000 Investment in Small 60,000 After this entry, the worksheet process would no longer require an adjustment in Entry (A) to recognize goodwill. The impairment loss would simply carry over to the consolidated income column. The impairment loss would be reported as a separate line item in the operating section of the consolidated income statement.


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25. c. (continued) GIANT COMPANY AND SMALL COMPANY

Consolidation Worksheet For Year Ending December 31, 2013

Consolidation Entries Consolidated Accounts Giant Small Debit Credit Totals Revenues ............................................................ (1,175,000) (360,000) (1,535,000) Cost of goods sold ............................................. 550,000 90,000 640,000 Depreciation expense ........................................ 172,000 130,000 (E) 5,000 307,000 Equity income of Small ...................................... (135,000) -0- (I) 135,000 -0- Net income .................................................... (588,000) (140,000) (588,000) Retained earnings 1/1 ........................................ (1,417,000) (620,000) (S) 620,000 (1,417,000) Net income (above) ............................................ (588,000) (140,000) (588,000) Dividends paid ................................................... 310,000 110,000 (D) 110,000 310,000 Retained earnings 12/31 .............................. (1,695,000) (650,000) (1,695,000) Current assets .................................................... 398,000 318,000 (P) 10,000 706,000 Investment in Small ........................................... 995,000 -0- (D) 110,000 (S) 790,000 -0- (A) 180,000 (I) 135,000 Land ................................................................. 440,000 165,000 (A) 90,000 695,000 Buildings (net) .................................................... 304,000 419,000 723,000 Equipment (net) .................................................. 648,000 286,000 (A) 30,000 (E) 5,000 959,000 Goodwill .............................................................. -0- -0- (A) 60,000 60,000 Total assets .................................................. 2,785,000 1,188,000 3,143,000 Liabilities ............................................................ (840,000) (368,000) (P) 10,000 (1,198,000) Common stock ................................................... (250,000) (170,000) (S)170,000 (250,000) Retained earnings (above) ................................ (1,695,000) (650,000) (1,695,000) Total liabilities and equity ............................ (2,785,000) (1,188,000) (3,143,000) Parentheses indicate a credit balance.


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26. (30 Minutes) (Determine consolidated accounts and consolidation entries five years after purchase. Parent applies equity method. ) a. Fair Value Allocation and Annual Amortization

Annual Excess Allocation Life Amortizations

Land ..................................... $20,000 Buildings .............................. (30,000) 10 yrs. $(3,000) Equipment ............................ 60,000 5 yrs. 12,000 Customer List ...................... 100,000 20 yrs. 5,000 Total ..................................... $14,000

CONSOLIDATED TOTALS

Revenues = $850,000 (add the two book values)

Cost of G oods Sold = $380,000 (the accounts of both companies are added together)

Depreciation Expense = $179,000 (the accounts are added and include the excess depreciation adjustment of $9,000)

Amortization Expense = $5,000 (current amortization for customer list recognized in acquisition)

Buildings (net) = $625,000 (add the two book values less the purchase price allocation [a $30,000 reduction] after removing 5 years of amortization totaling $15,000)

Equipment (net) = $450,000 (add the two book values. The purch ase price allocation is completely amortized at end of current year)

Customer List = $75,000 ($100,000 original allocation less $25,000 [5 years of amortization])

Common stock = $300,000 (parent company balance only)

Additional paid -in capital = $50,000 (parent company balance only) b. The method used by the parent is only important in determining the

parent's separate account balances (which are given here or are not needed) or consolidation worksheet entries (which are not required in a.)


3-31

26. (continued )

c. Consolidation Entry S Common Stock (Hill) ............................ 40,000 Additional paid -in capital (Hill) ........... 160,000 Retained Earnings 1/1 ......................... 600,000 Investment in Hill ............................ 800,000 (To eliminate beginning stockholders' equity of subsidiary) Consolidation Entry A Land ...................................................... 20,000 Equipment (net) ................................... 12,000 Customer List (net) .............................. 80,000 Buildings (net) ................................ 18,000 Investment in Hill ............................ 94,000

(To record unamortized allocation balances as of beginning of current year)

Consolidation Entry I Investment Income .............................. 86,000 Investment in Hill ............................ 86,000

(To remove equity income recognized during year —equity method accrual of $100,000 [based on subsidiary's income] less amortization of $14,000 for the year)

Consolidation Entry D Investment in Hill ................................. 40,000 Dividends Paid ................................ 40,000 (To remove Intercompany dividend payments) Consolidation Entry E Amortization expense ........................... 5,000 Depreciation expense ........................... 9,000 Buildings .............................................. 3,000 Equipment ........................................ 12,000 Customer List .................................. 5,000 (To recognize excess acquisition -date fair -value amortizations for the period)

27. (30 Minutes) (Determine parent company and consolidated account

balances for a bargain purchase combination. Parent applies equity method )

a. Acquisition -Date Fair Value Allocation and Annual Excess Amortization

Consideration transferred ............. $1,090,000 Santiago book value (given) .......... $950,000 Technology undervaluation (6 yr. life) 240,000


3-32

Acquisition fair value of net assets 1,190,000 Gain on bargain purchase .............. $(100,000) Santiago income .............................. $(200,000) Technology amortization ................ 40,000 Equity earnings in Santiago ........... $(160,000) Fair value of net assets at acquisition -date $1,190,000 Equity earnings from Santiago ....... 160,000 Dividends received .......................... (50,000) Investment in Santiago 12/31/11 .... $1,300,000

Because a bargain purchase occurred, Santiago’s net asset fair value replaces the fair value of the consideration transferred as the initial value assigned to the subsidiary on Peterson’s books. b.

Income Statement Peterson Santiago Adj. & Elim. Consolidated Revenues (535,000) (495,000) (1,030,000) Cost of goods sold 170,000 155,000 325,000 Gain on bargain purchase (100,000) -0- (100,000) Depreciation and amortization 125,000 140,000 (E) 40,000 305,000 Equity earnings in Santiago (160,000) -0- (I) 160,000 -0- Net income (500,000) (200,000) (500,000) Statement of Retained Earnings Retained earnings, 1/1 (1,500,000) (650,000) (S) 650,000 (1,500,000) Net income (above) (500,000) (200,000) (500,000) Dividends paid 200,000 50,000 (D) 50,000 200,000 Retained earnings, 12/31 (1,800,000) (800,000) (1,800,000) Balance Sheet Current assets 190,000 300,000 490,000 Investment in Santiago 1,300,000 -0- (D) 50,000 (I) 160,000

(S)

950,000 -0-

(A)

240,000 Trademarks 100,000 200,000 300,000

Patented technology 300,000 400,000 (A) 240,000 (E)

40,000 900,000 Equipment 610,000 300,000 910,000 Total assets 2,500,000 1,200,000 2,600,000 Liabilities (165,000) (100,000) (265,000) Common stock (535,000) (300,000) (S) 300,000 (535,000) Retained earnings, 12/31 (1,800,000) (800,000) (1,800,000) Total liabilities and equity (2,500,000) (1,200,000) 1,440,000 1,440,000 (2,600,000)


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28. (35 minutes) (Acquisition method: Contingent performance obligation and worksheet adjustments for equity and initial value methods.) a. Investment in Wolfpack, Inc. 500,000 Contingent performance obligation 35,000 Cash 465,000 b. 12/31/11 Loss from increase in contingent performance obligation 5,000 Contingent performance obligation 5,000 12/31/12 Loss from increase in contingent performance obligation 10,000 Contingent performance obligation 10,000 12/31/12 Contingent performance obl igation 50,000 Cash 50,000 c. Equity Method Common stock - Wolfpack 200,000 Retained earnings -Wolfpack 180,000 Investment in Wolfpack 380,000 Royalty agreements 90,000 Goodwill 60,000 Investment in Wolfpack 150,000 Equity earnings of Wol fpack 65,000 Investment in Wolfpack 65,000 Investment in Wolfpack 35,000 Dividends paid 35,000 Amortization expense 10,000 Royalty agreements 10,000 d. Initial Value Method Investment in Wolfpack 30,000 Retained earnings -Branson 30,000 Common stock 200,000 Retained earnings -Wolfpack 180,000 Investment in Wolfpack 380,000 28. (continued )


3-34

Royalty agreements 90,000 Goodwill 60,000 Investment in Wolfpack 150,000 Dividend income 35,000 Dividends paid 35,000 Amortization ex pense 10,000 Royalty agreements 10,000

29. (45 Minutes) (Prepare consolidation worksheet five years after purchase.

Parent applies equity method. Includes question on push -down accounting.) a. Allocation of Acquisition -Date Fair Value and Determinati on of

Amortization: Storm’s acquisition -date fair value .................... $140,000 Book value of Storm (acquisition date) ............. (105,000) Fair value in excess of book value .................... $35,000

Excess assigned to specific accounts: Annual Excess Life Amortizations Land ........................................... $10,000 – – Equipment ................................. 5,000 5 yrs. $1,000 Formula ...................................... 20,000 20 yrs. 1,000 Total ................................................ $35,000 $2,000

The equity in subsidiary earnings account reflects the equity method. The initial value method would have recorded $40,000 (100% of div idend payments) as income while the partial equity method would have shown $68,000 (100% of the subsidiary's income). Under the equity method, an income accrual of $66,000 is recognized (100% of reported income less the $2,000 in excess amortization expens es computed above).

b. Explanation of Consolidation Entries Found on Worksheet

Entry S —Eliminates stockholders' equity accounts of the subsidiary as of the beginning of the current year.

Entry A —Records remaining unamortized allocation from acquisit ion -

date fair value adjustments. As of the beginning of the current year, equipment and formula have undergone four years of amortization.

Entry I —Eliminates intercompany income accrual for the current year.

Entry D —Eliminates intercompany dividend trans fers.

Entry E —Recognizes excess amortization expenses for current year.


3-35

2009 Consolidation Entries S Common Stock 60,000 APIC 5,000 Retained earnings 40 ,000 Investment in Storm 105,000

A Land 10,000 Bld. & Equip. 5,000 Formula 20,000 Investment in Storm 35,000


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I Equity in Sub Earnings Investment in Storm D Investment in Storm (Dividends paid) Dividends Paid E Depreciation Expense 1000 Amortization Expense 1000 Bld. & Equip. 1000 Formula 1000


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2013 Cons olidation Entries S Common Stock 60,000 APIC 5,000 Retained earnings 98,000 Investment in Storm 163,000 A Land 10,000 Bld. & Equip. 1,000 Formula 16,000 Investment in Storm 27,000


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I Equity in Sub Earnings 66,000 Investment in Storm 66,000 D Investment in Storm 40,000 Dividends Paid 40,000 E Depreciation Expense 1000 Amortization Expense 1000 Bld. & Equip. 1000 Formula 1000


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29. (continued) Palm and Subsidiary Consolidated Worksheet for year ended Dec ember 31, 2013

Consolidation Entries Consolidated Accounts Palm Co. Storm Co. Debit Credit Totals Income Statement Revenues .......................................................... (485,000) (190,000) (675,000) Cost of goods sold ........................................... 160,000 70,000 230,000 Depreciation expense ...................................... 130,000 52,000 (E) 1,000 183,000 Amortization expense ...................................... -0- -0- (E) 1,000 1,000 Equity in subsidiary earnings ......................... (66,000) -0- (I) 66,000 -0- Net income .................................................. (261,000) (68,000) (261,000) Statement of Retained Earnings Retained earnings 1 /1 ...................................... (659,000) (98,000) (S) 98,000 (659,000) Net income (above) .......................................... (261,000) (68,000) (261,000) Dividends paid ................................................. 175,500 40,000 (D) 40,000 175,500 Retained earnings 12/31 ............................ (744,500) (126,000) (744,500) Balance Sheet Current assets .................................................. 268,000 75,000 343,000 Investment in Storm Co. .................................. 216,000 -0- (D) 40,000 (S) 163,000 -0- (A) 27,000 (I) 66,000 Land ............................................................... 427,500 58,000 (A) 10,000 495,500 Buildings and equipment (net) ........................ 713,000 161,000 (A) 1,000 (E) 1,000 874,000 Formula ............................................................. -0- -0- (A) 16,000 (E) 1,000 15,000 Total assets ................................................ 1,624,500 294,000 1,727,500 Current liabilities .............................................. (110,000) (19,000) (129,000) Long -term liabilities ......................................... (80,000) (84,000) (164,000) Common stock ................................................. (600,000) (60,000) (S) 60,000 (600,000) Additional paid -in capital ................................. (90,000) (5,000) (S) 5,000 (90,000) Retained earnings 12/31 .................................. (744,500) (126,000) (744,500) Total liabilities and equity .......................... (1,624,500) (294,000) (1,727,500) Parenthese s indicate a credit balance.


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29. (continued)

c. If push -down accounting had been applied, the purchase price allocations to land ($10,000), equipment ($5,000), and formula ($20,000) would have been entered into the subsidiary's balances with an offsetti ng $35,000 increase in additional paid -in capital. The equipment and the formula would then have been amortized by the subsidiary as annual expenses of $1,000 each. For 2013, the subsidiary's expenses would have been $2,000 higher leaving reported net inco me at $66,000. At the end of 2013, land would still have been $10,000 higher because no amortization is recorded on that asset. Equipment would be no higher at this time since the $5,000 allocation is fully depreciated at the end of this fifth year. Howeve r, the secret formula would be recorded by the subsidiary as $15,000, the $20,000 allocation less five years of amortization at $1,000 per year.

30. (20 Minutes) (Consolidated balances three years after purchase. Parent has applied the equity method. )

a. Schedule 1 —Acquisition -Date Fair Value Allocation and Amortization Jasmine’s acquisition -date fair value $206,000 Book value of Jasmine .................. (140,000) Fair value in excess of book value 66,000 Excess fair value assigned to specific accounts based on individual fair values Annual Excess Life Amortization Equipment ................................. 54,400 8 yrs. $6,800 Buildings (overvalued) ............. (10,000) 20 yrs. (500) Goodwill ..................................... $21,600 indefinite -0- Total ........................................... $6,300 Investment in Jasmine Company —12/31/11 Jasmine’s acquisition -date fair value ............................ $206,000 2009 Increase in book value of subsidiary ................... 40,000 2009 Excess amortizations (Schedule 1) ..................... (6,300) 2010 Increase in book value of subsidiary ................... 20,000 2010 Excess amortizations (Schedule 1) ..................... (6,300) 2011 Increase in book value of subsidiary ................... 10,000 2011 Excess amortizations (Schedule 1) ..................... (6,300) Investment in Jasmine Company ............................ $257,100


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30. (continued) b. Equity in Subsidiary Earnings Income accrual ................................................................ $30,000 Excess amortizations (Schedule 1) .............................. (6,300) Equity in subsidiary earnings .................................. $23,700 c. Consolidated Net Income Consolidated revenues (add book values) .................. $414,000 Consolidated expenses (add book values) .................. (272,000) Excess amortization expenses (Schedule 1) ............... (6,300) Consolidated net income ............................................... $135,700 d. Consolidated Equipment Book values added together ......................................... $370,000 Allocation of purchase price ......................................... 54,400 Excess depreciation ($6,800 × 3) .................................. (20,400) Consolidated equipment .......................................... $404,000

e. Consolidated Buildings .................................................. Book values added together ......................................... $288,000 Allocation of purchase price ......................................... (10,000) Excess depreciation ($500 × 3) ..................................... 1,500 Consolidated buildings ............................................. $279,500

f. Consolidated goodwill Allocation of excess fair value to goodwill ................... $21,600

g. Cons olidated Common Stock ........................................ $290,000

As a purchase, the parent's balance of $290,000 is used (the acquired company's common stock will be eliminated each year on the consolidation worksheet).

h. Consolidated Retained Earnings ................................... $410,000

Tyler's balance of $410,000 is equal to the consolidated total because

the equity method has been applied. 31. (35 minutes) (Consolidation with IPR&D, equity method) a. Consideration transferred 1/1/10 $1,765,000 Increase in Salsa’s RE to1/1/11 150,000 In-process R&D write -off in 2010 (44,000) Amortizations 2010 (7,000) Income 2011 210,000 Dividends paid 2011 (25,000) Amortization 2011 (7,000) Investment balance 12/31/11 $2,042,000


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31. (continued)

b. Picante and Subsidiary Salsa Consolidated Worksheet

for the year ended December 31, 2011 12/31/11 12/31/11 Accounts Picante Salsa Adjustments Consolidated Sales (3,500,000) (1,000,000) (4,500,000) Cost of Goods Sold 1,600,000 630,000 2,230,000 Depreciation Expense 540,000 160,000 (E) 7,000 707,000 Subsidiary Income (203,000) (I) 203,000 -0- Net Income (1,563,000) (210,000) (1,563,000) Ret. Earnings 1/1/11 (3,000,000) (800,000) (S) 800,000 (3,000,000) Net Income (1,563,000) (210,000) (1,563,000) Dividends Paid 200,000 25,000 (D) 25,000 200,000 Ret. Earnings 12/31/11 (4,363,000) (985,000) (4,363,000) Cash 228,000 50,000 278,000 Accounts Receivable 840,000 155,000 995,000 Inventory 900,000 580,000 1,480,000 Investment in Salsa 2,042,000 (D) 25,000 (S)1,800,000 -0- (A) 64,000 (I) 203,000 Land 3,500,000 700,000 4,200,000 Equipment (net) 5,000,000 1,700,000 (A) 49,000 (E) 7,000 6,742,000 Goodwill 290,000 -0- (A) 15,000 305,000 Total Assets 12,800,000 3,185,000 14,000,000 Accounts Payable (193,000) (400,000) (593,000) Long -term Debt (3,094,000) (800,000) (3,894,000) Common Stock —Picante (5,150,000) (5,150,000) Common Stock —Salsa (1,000,000) (S)1,000,000 Ret. Earnings 12/31/11 (4,363,000) (985,000) (4,363,000) (12,800,000) (3,185,000) 2,099,000 2,099,000 (14,000,000) 32. (55 minutes) (Goodwill impairment test, consolidated balances, and

worksheet) a. Prine should c ompare Lydia’s total fair value to its carrying value, as

follows: 12/31 Carrying value (equity method balance) $120,070,000 12/31 Fair value 110,000,000 Excess carrying value over fair value $10,070,000


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Because fair value is less than carrying value, Prine is required to further test whether goodwill is impaired.

b. 12/31 Fair value for Lydia $110,000,000 Fair values of assets and liabilities Cash $109,000 Receivables (net) 897,000 Movie library 60,000,000 Broadcast licenses 20,000,000 Equipment 19,000,000 Current liabilities (650,000) Long -term debt (6,250,000) Total net fair value 93,106,000 Implied fair value for goodwill 16,894,000 Carrying value for goodwill 50,000,000 Impairment loss $33,106,000 Journal Entry by Prine: Goodwill impairment loss 33,106,000 Investment in Lydia Co. 33,106,000 c. Combined revenues $30,000,000 Combined expenses (including excess amortization) 22,200,000 Income before impairment loss 7,800,000 Goodw ill impairment loss —Lydia (33,106,000) Net loss $(25,306,000) d. Consolidated goodwill = $50,000,000 – $33,106,000 = $16,894,000 32. (continued) e. Consolidated broadcast licenses = $350,000 + $14,014,000 = $14,364,000 The consolidated balance equals the sum of parent’s book value plus

the fair value of the subsidiary broadcast licenses at acquisition date adjusted for any changes since acquisition. Because the subsidiary’s book value equaled fair value at acquisition date, no worksheet adjust ment is needed. Because the broadcast licenses are considered to have indefinite lives, they are not amortized. Note that the 12/31 fair value, assessed for purposes of computing implied value for goodwill, is not used for financial reporting purposes.


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32. f. (continued) Prine and Lydia Consolidated Worksheet

December 31 Adjusting Entries Consolidated Accounts Prine, Inc. Lydia Co. Debit Credit Totals Revenues (18,000,000) (12,000,000) (30,000,000) Expenses 10,350,000 11,800,000 (E) 50,000 22,200,000 Equity in Lydia earnings (150,000) -0- (I) 150,000 -0- Impairment loss 33,106,000 -0- 33,106,000 Net income/loss 25,306,000 (200,000) 25,306,000 Retained Earnings 1/1 (52,000,000) (2,000,000) (S) 2,000,000 (52,000,000) Dividends paid 300,000 80,000 (D) 80,000 300,000 Net income 25,306,000 (200,000) 25,306,000 Retained earnings 12/31 (26,394,000) (2,120,000) (26,394,000) Cash 260,000 109,000 369,000 Receivables (net) 210,000 897,000 1,107,000 Investment in Lydia, Co. 86,964,000 -0- (D) 80,000 (S)69,500,000 -0- (A)17,394,000 (I) 150,000 Broadcast licenses 350,000 14,014,000 14,364,000 Movie library 365,000 45,000,000 45,365,000 Equipment (net) 136,000,000 17,500,000 (A) 500,000 (E) 50,000 153,950,000 Goodwill -0- -0- (A)16,894,000 16,894,000 Total assets 224,149,000 77,520,000 232,049,000 Current Liabilities (755,000) (650,000) (1,405,000) Long -term Debt (22,000,000) (7,250,000) (29,250,000) Common stock (175,000,000) (67,500,000) (S)67,500,000 (175,000,000) Retained earnings 12/31 (26,394,000) (2,120,000) (26,394,000) Total liabilities and equity (224,149,000) (77,520,000) (232,049,000)


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FARS Case Solution

Jonas recognized several identifiable intangibles from its acquisition of Innovation+. Jonas expresses the desire to expense these intangible assets in the acquisition period.

1. Advise Jonas on the acceptability of its suggested immediate write -off.

An intangible asset should not be written down or off in the period of acquisition unless it becomes impaired during that period.

2. Indicate the relevant factors to consider in allocatin g the values assigned to identifiable intangibles acquired in a business combination.

The accounting for a recognized intangible asset is based on its useful life to the reporting entity. An intangible asset with a finite useful life is amor tized; an intangible asset with an indefinite useful life is not amortized. The useful life of an intangible asset to an entity is the period over which the asset is expected to contribute directly or indirectly to the future cash flows of that entity. Other factors to be considered are legal, regulatory, or contractual provisions, effects of obsolescence, demand, competition, and other economic factors, and the level of maintenance expenditures required to obtain the expected future cash flows from the asset. (paragraph 11 SFAS 142)

The price paid by Jonas for Innovation+ indicates a large amount was paid for goodwill. However, Jonas worries that any future goodwill impairment may send the wrong signal to its investors about the wisdom of the Innovation+ acquisition. Jonas thus wishes to allocate all the goodwill to one account called “enterprise goodwill.” In this way, Jonas hopes to minimize the possibility of goodwill impairment because a decline in goodwill in one business unit may be offset by an increase in the value of goodwill in another business unit.

3. Jonas’ suggested treatment of goodwill is inappropriate. To ensure that goodwill increases in one reporting unit do not offset decreases in others, goodwill acquired in a business combination is allocated across business units that benefit from the goodwill.

Per the FASB ASC:

For the purpose of testing goodwill for impairment, all goodwill acquired in a business combination shall be assigned to one or more reporting units as of the acquisition date. Goodwill shall be assigned to reporting units of the acquiring entity that are expected to benefit from the synergies of the combination even though other assets or liabilities of the acquired entity may not be assigned to that reporting unit. The total amount of acquired goodwill may be divided among a number of reporting units. The methodology used to determine the amount of goodwill to assign to a reporting unit shall be reasonable and supportable and shall be applied in a consistent manner.


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Therefore, Jonas’ desire to minimize the possibility of goodwill impairment should not be a factor in allocating goodwill to reporting units.

Sprint Nextel Research Case Solution —Goodwill Impairment

1) Sprint reported a $29.7 billion non -cash goodwill impairment charge in 200 7

2) Sprint wrote down their goodwill in 2007 because they experienced a sustained, significant decline in their stock price, which was due in large part to “fewer than expected net subscriber additions.” The following examples are provided as possible interim triggering events in FASB ASC 350-20-35-30): • A s ignificant adverse change in legal factors or in the business climate • An adverse action or assessment by a regulator • Unanticipated competition • A loss of key personnel • A "m ore likely than not" expectation that a reporting unit or a

significant portion of a reporting unit will be sold or otherwise disposed of • The testing f or recoverability under FAS 144 or a significant asset group within a reporting unit • Recognition of a goodwill impairment loss in the standalone financial statements of a subsidiary that is a component of a reporting unit.

3) Consolidated Balance Sheets: Goodwill down from $30,904 in 2006 to $935 in

2007 (in millions) Consolidated Statement of Operations: Goodwill impairment: $29,729 million Consolidated Statem ent of Cash Flows: Goodwill impairment: $ 29,729 million

4) Sprint reviews their goodwill for impairment annually or more frequently if

events or changes in circumstances indicate that the asset might be impaired. Testing Steps: • First step: compare the fair value of their wireless reporting unit with its

net book value. If the fair value of the wir eless reporting unit exceeds its net book value, goodwill is not impaired, and no further testing is necessary. If the net book value of the wireless reporting unit exceeds its fair value, a second test is performed. • Second step: compare the implied fa ir value of goodwill with that recorded on the balance sheet. Implied fair value of goodwill is determined in the same manner as if the wireless reporting unit were being acquired in a business combination. Specifically, fair value of the wireless reportin g unit is allocated to all of the assets and liabilities of that unit, including any unrecognized intangible assets, in a hypothetical calculation that would yield the implied fair value of goodwill. If the


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implied fair value of goodwill is less than the goodwill recorded on their balance sheet, an impairment charge is recorded for the difference.

5) Sprint incurred a $163 million impairment charge for their long -lived assets in

2007, primarily attributable to their Wireless segment, which included the wri te-off of cell site development costs that they abandoned as the sites would not be used based on management’s strategic network plans, the sale of Velocita Wireless, and the closing of retail stores due to integration effo rts. There was no impairment char ge for intangible assets both indefinite -lived and finite -lived. Sprint tests other indefinite -lived intangibles for impairment by comparing the asset’s respective net book value to estimates of fair value. (One-step) The test is done annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. (Same as goodwill) Sprint reviews their long -lived assets (including intangible assets with a finite life ) for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The assets are impaired if the total of the expected undiscounted future cash flows is less than the carrying amount of their long -lived assets, a loss is recognized for the difference between the fair value and carrying value of the assets (Two-step) .

6) GAAP prohibits reversal of impairment loss for goodwill. IFRS also prohibits reversal of impairment loss for goodwill

7) No, the requirement for goodwill impairment is different under IFRS. Under

IFRS, Goodwill impairment testing is performed under a one-step approach: The recoverable amount of the CGU (cash -generating unit) or group of CGUs (i.e., the higher of its fair value minus costs to sell and its value in use) is compared with its carrying amoun t. Any impairment loss is recognized in operating results as the excess of the carrying amount over the recoverable amount. The impairment loss is allocated first to goodwill and then on a pro rata basis to the other assets of the CGU or group of CGUs to t he extent that the impairment loss exceeds the book value of goodwill.

IAS 36 Impairment of Assets: 88. When, as described in paragraph 81, goodwill relates to a cash -generating unit but has not been allocated to that unit, the unit shall be tested for impairment, whenever there is an indication that the unit may be impaired, by comparing the unit’s carrying amount, excluding any goodwill, with its recoverable amount. Any impairment loss shall be recognised in accordance with paragraph 104.

90. A cash -generating unit to which goodwill has been allocated shall be tested for impairment annually, and whenever there is an indication that the


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unit may be impaired, by comparing the carrying amount of the unit, including the goodwill, with the recoverable amoun t of the unit. If the recoverable amount of the unit exceeds the carrying amount of the unit, the unit and the goodwill allocated to that unit shall be regarded as not impaired. If the carrying amount of the unit exceeds the recoverable amount of the unit, the entity shall recognise the impairment loss in accordance with paragraph 104.

104. An impairment loss shall be recognised for a cash -generating unit (the smallest group of cash -generating units to which goodwill or a corporate asset has been allocated ) if, and only if, the recoverable amount of the unit (group of units) is less than the carrying amount of the unit (group of units). The impairment loss shall be allocated to reduce the carrying amount of the assets of the unit (group of units) in the following order: (a) first, to reduce the carrying amount of any goodwill allocated to the cash -generating unit (group of units); and (b) then, to the other assets of the unit (group of units) pro rata on the basis of the carrying amount of each asset in the unit (group of units). These reductions in carrying amounts shall be treated as impairment losses on individual assets and recognised in accordance with paragraph 60.

AOL Time Warner Analysis Case Solution —Goodwill Impairment

1. How did AOL determine the initial amount of goodwill to recognize in its

merger with Time Warner?

The merger of America Online and Time Warner has been accounted for by AOL Time Warner as an acquisition of Time Warner under the purchase method of accounting for business combi nations.

Under the purchase method of accounting, the cost, including transaction costs, to acquire Time Warner was allocated to the underlying net assets, based on their respective estimated fair values.

The excess of the purchase price over the estimated fair values of the net assets acquired was recorded as goodwill.

2. How did AOL Time Warner determine the $99 billion impairment charge to its

goodwill? What procedures will Time Warner follow in the future to assess the value of its goodwill?

AOL Time Warner determined the goodwill write -down by employing the two -step impairment test. In step one, the carrying value of each reporting unit was compared to its fair value. If the book value of the reporting unit exceeded the fair value, AOL employed st ep two by comparing goodwill’s book value to its implied fair value.


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From the 2002 annual report:

The $54.199 billion goodwill impairment is associated entirely with goodwill resulting from the Merger. The amount of the impairment primarily reflects the decline in the Company's stock price since the Merger was announced and valued for accounting purposes in January of 2000. Prior to performing the review for impairment, FAS 142 required that all goodwill deemed to be related to the entity as a whole be a ssigned to all of the Company's reporting units, including the reporting units of the acquirer. This differs from the previous accounting rules where goodwill was assigned only to the businesses of the company acquired. As a result, a portion of the goodwi ll generated in the Merger has been realloca ted to the AOL segment. During the fourth quarter of 2002, the Company performed its annual impairment review for goodwill and other intangible assets and recorded an additional charge of $45.538 billion, which is recorded as a component of operating income in the accompanying consolidated statement of operations. The $45.538 billion is reflective of the overall decline in market values and includes charges to reduce the carrying value of goodwill at the AOL segment ($33.489 billion), Cable segment ($10.550 billion) and Music segment ($646 million), as well as a charge to reduce the carrying value of brands and trademarks at the Music segment ($853 million).

3. What business areas has AOL designated as its repor ting units? Why is it

important to define the reporting unit?

A reporting unit is an operating segment or a component. AOL’s reporting units are consistent with its operating segments, which are classified based on different business interest areas as fol lows:

1ST quarter 2002 Reporting Units impairment loss AOL -0- Cable $22,980 Filmed Entertainment 4,091 Networks 13,077 Music 4,796 Publishing 9,259 Total 1 st quarter 2002 impairment losses $54,203

Since the goodwill impairment test is dependent upon the fair value of a reporting unit, companies may prefer to aggregate operating segment


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components when identifying reporting units so that they can reduce the probability of a goodwill impairment charge.

4. What effects did SFAS 142 have on AOL Time Warner’s earnings performance both in the short term and in the long run?

In the short term, the $54 billion directly reduced AOL Time Warner’s net income and retained earnings, resulting in a net loss of $54.240 billion in the first qua rter.

Because this charge was recorded as “cumulative effect of accounting change,” it didn’t affect AOL’s operating income. As a non -cash charge, it didn’t affect cash flow either. However, the 4 th quarter charge of $45.5 billion, was recorded as a comp onent of operating income in the accompanying consolidated statement of operations. Only in the 1 st quarter of 2002 were firm’s allowed to avoid reporting goodwill impairment losses in operating income.

In the long run, SFAS 142 eliminated the amortization of goodwill, but companies face the risk of further goodwill impairment. So, the rule may make Time Warner and other public companies more accountable for acquisition choices.

5. The rationale is to improve the financial reporting. The accounting trea tment

for goodwill should better reflect the underlying economics of goodwill. Instead of regarding goodwill as a steadily “wasting” asset, the impairment method regards the goodwill as one that sporadically declines or even conceivably maintains its value in perpetuity, which is consistent with the concept of representational faithfulness.

Excel Case 1 Solution a. Innovus employs initial value method to account for ChipTech.

Innovus ChipTech Adjustments Consolidated Revenues (990,000) (210,000) (1,200,000) Cost of good sold 500,000 90,000 590,000 Depreciation expense 100,000 5,000 105,000 Amortization expense 55,000 18,000 (E) 20,000 93,000 Dividend income (40,000) -0- (I) 40,000 -0- Net Income (375,000) (97,000) (412,000) Retained earnings 1/1 (1,555,000) (450,000) (S)450,000 (C*) 60,000 (1,615,000) Net income (375,000) (97,000) (412,000) Dividends paid 250,000 40,000 (I) 40,000 250,000 Retained earnings 12/31 (1,680,000) (507,000) (1,777,000) Current assets 960,000 355,000 1,315,000


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Investment in Chiptech 670,000 (C*) 60,000 (S) 580,000 (A) 150,000 -0- Equipment (net) 765,000 225,000 990,000 Trademark 235,000 100,000 (A) 36,000 (E) 4,000 367,000 Existing technology 0 45,000 (A) 64,000 (E) 16,000 93,000 Goodwill 450,000 -0- (A) 50,000 500,000 Total assets 3,080,000 725,000 3,265,000 Liabilities (780,000) (88,000) (868,000) Common stock (500,000) (100,000) (S)100,000 (500,000) Additional paid -in capital (120,000) (30,000) (S) 30,000 (120,000) Retained earnings 12/31 (1,680,000) (507,000) (1,777,000) Total liabilities and equity (3,080,000) (725,000) 850,000 850,000 (3,265,000)

Excel Case 1 Solution (continued) b. Innovus employs initial value method to account for ChipTech and goodwill is impaired.

Innovus ChipTech Consolidated Revenues (990,000) (210,000) (1,200,000) Cost of good sold 500,000 90,000 590,000 Depreciation expense 100,000 5,000 105,000 Amortization expense 55,000 18,000 (E) 20,000 93,000 Impairment loss 50,000 50,000 Dividend income (40,000) -0- (E) 40,000 -0- Net Income (325,000) (97,000) (362,000) Retained earnings 1/1 (1,555,000) (450,000) (S)450,000 (C) 60,000 (1,615,000) Net income (325,000) (97,000) (362,000) Dividends paid 250,000 40,000 (D) 40,000 250,000 Retained earnings 12/31 (1,630,000) (507,000) (1,727,000) Current assets 960,000 355,000 1,315,000 Investment in Chiptech 620,000 (C) 60,000 (S)580,000 (S)150,000 -0- Equipment (net) 765,000 225,000 990,000 Trademark 235,000 100,000 (A) 36,000 (E) 4,000 367,000 Existing technology -0- 45,000 (A )64,000 (E) 16,000 93,000 Goodwill 450,000 -0- (A) 50,000 50,000 450,000 Total assets 3,030,000 725,000 3,215,000 Liabilities (780,000) (88,000) (868,000) Common st ock (500,000) (100,000) (S)100,000 (500,000) Additional paid -in capital (120,000) (30,000) (S) 30,000 (120,000)


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Retained earnings 12/31 (1,630,000) (507,000) (1,727,000) Total liabilities and equity (3,030,000) (725,000) 900,000 900,000 (3,215,000) Alternatively, the goodwill impairment loss could have been recorded as an adjustement on the worksheet. Excel Case 2 Solution Part a: Investment in Wi-Free account balance 12/31/11 Wi-Free’s acquisition -date fair value $730,000 Change in Wi-Free’s retained earnings for 2010 80,000 2010 amortization (4,500) 2010 in-process R&D write -off (75,000) 2011 reported Wi -Free income 180,000 2011 Wi-Free dividend (50,000) 2011 amortization (4,500) Balance 12/31/11 $856,000

Part b: Consolidation Entries Consolidated

Hi-Speed Wi-Free Debit Credit Totals Revenues (1,100,000) (325,000) (1,425,000) Cost of good sold 625,000 122,000 747,000 Depreciation expense 140,000 12,000 152,000 Amortization expens e 50,000 11,000 (E) 12,000 (E) 7,500 65,500 Equity in subsidiary earnings (175,500) -0- (I)175,500 -0- Net Income (460,500) (180,000) (460,500) Retained earnings 1/1 (1,552,500) (450,000) (S)450,000 (1,552,500) Net income (460,500) (180,000) (460,500) Dividends paid 250,000 50,000 (D) 50,000 250,000 Retained earnings 12/31 (1,763,000) (580,000) (1,763,000) Current assets 1,034,000 345,000 (P) 30,000 1,349,000 Investment in Wi -Free 856,000 (D) 50,000 (I) 175,500 (S)580,000 (A)150,500 0 Equipment (net) 713,000 305,000 1,018,000 Computer software 650,000 130,000 (E) 7,500 (A) 22,500 765,000 Internet domain name 0 100,000 (A)108,000 (E) 12,000 196,000 Goodwill -0- -0- (A) 65,000 65,000 Total assets 3,253,000 880,000 3,393,000 Liabilities (870,000) (170,000) (P) 30,000 (1,010,000)


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Common stock (500,000) (110,000) (S)110,000 (500,000) Additional paid -in capital (120,000) (20,000) (S) 20,000 (120,000) Retained earnings 12/3 1 (1,763,000) (580,000) (1,763,000) Total liab. and equity (3,253,000) (880,000) 1,028,000 1,028,000 (3,393,000)

Chapter 3 - Computer Project PECOS COMPANY AND SUARO COMPANY Consolidated Information Worksheet

Pecos Suaro Revenues (1,052,000) (427,000) Operating expenses 821,000 262,000 Amortization of intangibles 0 Goodwill impairment loss 0 Income of Suaro 0

Net income (165,000)

Retained earnings—Pecos, 1/1 Retained earnings—Suaro, 1/1 0 (201,000) Net income (above) 0 (165,000) Dividends paid 200,000 35,000

Retained earnings, 12/31 (331,000)

Cash 195,000 95,000 Receivables 247,000 143,000 Inventory 415,000 197,000 Investment in Suaro 0 Land 341,000 85,000 Equipment (net) 240,100 100,000 Software 0 312,000 Other intangibles 145,000 0 Goodwill 0 0

Total assets 932,000

Liabilities (1,537,100) (251,000) Common stock (500,000) (350,000) Retained earnings (above) (331,000)

Total liabilities and equity (932,000)


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Consolidated Information Worksheet (continued)

Fair Value Allocation Schedule Acquisition-date fair value 1,450,000 Book value 476,000

Excess fair value over book value 974,000

Amortizations and Write-off 2011 2012 Land (10,000) 0 0 Brand Name 60,000 0 0 Software 100,000 50,000 50,000 IPR&D 300,000 300,000 0 Goodwill 524,000 0 0 Total 974,000 350,000 50,000

Suaro's Retained Earnings Changes 2011 2012 Income 75,000 165,000 Dividends 0 35,000


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Chapter 3 - Computer Project Solution

PECOS COMPANY AND SUARO COMPANY Consolidated Workshee t

For the Year Ended December 31, 2012 EQUITY METHOD

Consolidation Entries Consolidated Pecos Suaro Debit Credit Totals

Revenues (1,052,000

) (427,000) (1,479,000) Operating expenses 821,000 262,000 1,083,000 Amortization of intangibles 0 0 (E) 50,000 50,000 Goodwill impairment loss 0 0 0 Income of Suaro (115,000) 0 (I) 115,000 0 Net income (346,000) (165,000) (346,000)

Retained earnings—Pecos, 1/1 (655,000) 0 (655,000) Retained earnings—Suaro, 1/1 0 (201,000) (S) 201,000 0 Net income (above) (346,000) (165,000) (346,000) Dividends paid 200,000 35,000 (D) 35,000 200,000 Retained earnings, 12/31 (801,000) (331,000) (801,000)

Cash 195,000 95,000 290,000 Receivables 247,000 143,000 390,000 Inventory 415,000 197,000 612,000


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Investment in Suaro 1,255,000 0 (D) 35,000 (S) 551,000 0 (A) 624,000 (I) 115,000 Consolidated Worksheet (continued)

Land 341,000 85,000 (A) 10,000 416,000 Equipment (net) 240,100 100,000 340,100 Software 0 312,000 (A) 50,000 (E) 50,000 312,000 Other intangibles 145,000 0 145,000 Brand name 0 0 (A) 60,000 60,000 Goodwill 0 0 (A) 524,000 524,000 Total assets 2,838,100 932,000 3,089,100

Liabilities (1,537,100) (251,000) (1,788,100) Common stock (500,000) (350,000) (S) 350,000 (500,000) Retained earnings (above) (801,000) (331,000) (801,000) Total liabilities and equity (2,838,100) (932,000) 1,385,000 1,385,000 (3,089,100)

Shaded items were provided on the Consolidated Information Worksheet


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Chapter 3 – Computer Project Solution

PECOS COMPANY AND SUARO COMPANY Consol idated Worksheet

For the Year Ended December 31, 2012 PARTIAL EQUITY METHOD

Consolidation Entries Consolidated Pecos Suaro Debit Credit Totals Revenues (1,052,000) (427,000) (1,479,000) Operating expenses 821,000 262,000 1,083,000 Amortization of intangibles 0 0 (E) 50,000 50,000 Goodwill impairment loss 0 0 0 Income of Suaro (165,000) 0 (I) 165,000 0 Net income (396,000) (165,000) (346,000)

Retained earnings—Pecos, 1/1 (1,005,000) 0 (*C) 350,000 (655,000) Retained earnings—Suaro, 1/1 0 (201,000) (S) 201,000 0 Net income (above) (396,000) (165,000) (346,000) Dividends paid 200,000 35,000 (D) 35,000 200,000 Retained earnings, 12/31 (1,201,000) (331,000) (801,000)

Cash 195,000 95,000 290,000 Receivables 247,000 143,000 390,000 Inventory 415,000 197,000 612,000 Investment in Suaro 1,655,000 0 (D) 35,000 (S) 551,000 0 (A) 624,000


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(I) 165,000 (*C) 350,000 onsolidated Worksheet (continued)


Liabilities (1,537,100) (251,000) (1,788,100) Common stock (500,000) (350,000) (S) 350,000 (500,000) Retained earnings (above) (1,201,000) (331,000) (801,000) Total liabilities and equity (3,238,100) (932,000) 1,785,000 1,785,000 (3,089,100)



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PECOS COMPANY AND SUARO COMPANY Consolidated Worksheet

For the Year Ended December 31, 2012 INITIAL VALUE METHOD

Consolidation Entries Consolidated Pecos Suaro Debit Credit Totals Revenues (1,052,000) (427,000) (1,479,000) Operating expenses 821,000 262,000 1,083,000 Amortization of intangibles 0 0 (E) 50,000 50,000 Goodwill impairment loss 0 0 0 Income of Suaro (35,000) 0 (I) 35,000 0 Net income (266,000) (165,000) (346,000)

Retained earnings—Pecos, 1/1 (930,000) 0 (*C) 275,000 (655,000) Retained earnings—Suaro, 1/1 0 (201,000) (S) 201,000 0 Net income (above) (266,000) (165,000) (346,000) Dividends paid 200,000 35,000 (I) 35,000 200,000 Retained earnings, 12/31 (996,000) (331,000) (801,000)

Cash 195,000 95,000 290,000 Receivables 247,000 143,000 390,000 Inventory 415,000 197,000 612,000 Investment in Suaro 1,450,000 0 (S) 551,000 0 (A) 624,000


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(*C) 275,000 Consolidated Worksheet (continued)


Liabilities (1,537,100) (251,000) (1,788,100) Common stock (500,000) (350,000) (S) 350,000 (500,000) Retained earnings (above) (996,000) (331,000) (801,000) Total liabilities and equity (3,033,100) (932,000) 1,545,000 1,545,000 (3,089,100)



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Chapter 3 – Computer Pr oject PECOS COMPANY AND SUARO COMPANY Goodwill Impairment Loss Effects Without With Impairment Impairment

Common shares outstanding 500,000 500,000

Consolidated net income/(loss) 346,000 (178,000)

Consolidated assets, 1/1/12 2,943,100 2,943,100

Consolidated assets, 12/31/12 3,089,100 2,565,100

Consolidated equity, 1/1/12 1,155,000 1,155,000

Consolidated equity, 12/31/12 1,301,000 777,000

Consolidated liabilities 1,788,100 1,788,100

Earnings-per-share 0.69 -0.36

Return on assets 11.47% -6.46%

Return on equity 28.18% -18.43%

Debt-to-equity 1.37 2.30


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PECOS COMPANY AND SUARO COMPANY Consolidated Worksheet

For the Year Ended December 31, 2012 EQUITY METHOD – GOODWILL IMPAIRMENT LOSS

Consolidation Entries Consolidated Pecos Suaro Debit Credit Totals Revenues (1,052,000) (427,000) (1,479,000) Operating expenses 821,000 262,000 1,083,000 Amortization of intangibles 0 0 (E) 50,000 50,000 Goodwill impairment loss 524,000 0 524,000 Income of Suaro (115,000) 0 (I) 115,000 0 Net income 178,000 (165,000) 178,000

Retained earnings—Pecos, 1/1 (655,000) 0 (655,000) Retained earnings—Suaro, 1/1 0 (201,000) (S) 201,000 0 Net income (above) 178,000 (165,000) 178,000 Dividends paid 200,000 35,000 (D) 35,000 200,000 Retained earnings, 12/31 (277,000) (331,000) (277,000)

Cash 195,000 95,000 290,000 Receivables 247,000 143,000 390,000 Inventory 415,000 197,000 612,000 Investment in Suaro 731,000 0 (D) 35,000 (S) 551,000 0 (A) 100,000


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(I) 115,000 Consolidated Worksheet (continued)

Land 341,000 85,000 (A) 10,000 416,000 Equipment (net) 240,100 100,000 340,100 Software 0 312,000 (A) 50,000 (E) 50,000 312,000 Other intangibles 145,000 0 145,000 Brand name 0 0 (A) 60,000 60,000 Goodwill 0 0 0 Total assets 2,314,100 932,000 2,565,100

Liabilities (1,537,100) (251,000) (1,788,100) Common stock (500,000) (350,000) (S) 350,000 (500,000) Retained earnings (above) (277,000) (331,000) (277,000) Total liabilities and equity (2,314,100) (932,000) 861,000 861,000 (2,565,100)


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