Solutions to Homework Assignment - Chapter 3

CHAPTER 3 CONSOLIDATIONS—SUBSEQUENT TO THE DATE OF ACQUISITION Answers to Discussion Questions How Does a Company Really Decide which Investment Method to Apply? Students can come up with dozens of factors that Pilgrim should consider in choosing its internal method of accounting for its subsidiary, Crestwood Corporation. The following is only a partial list of possible points to consider. 

Use of the information. If Pilgrim does not monitor its subsidiary’s income levels closely, applying the equity method may be not be fruitful. A company must plan to use the data before the task of accumulation becomes worthwhile. For example, Crestwood may use the information for evaluating the performance of the subsidiary’s managers.

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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.

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Size of dividend payments. If Crestwood distributes most of its income 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, its annual amortization charges are high, and use of the equity method might be preferred to show the amortization effect each reporting period. In this case, waiting until year end 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.

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Amount of intra-entity transactions. As with amortization, the volume of transfers can be an important element in deciding which accounting method to use. If few intra-entity 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.

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

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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 its 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, CCES reduces the investment account. In addition, any excess amortization expense associated CCES's acquisition-date fair value allocations 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 intra-entity 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 intra-entity. 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 intra-entity 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 acquisition-date fair value allocations. As will be discussed in detail in Chapter Five, intra-entity 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. McGraw-Hill/Irwin 3-2

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3.

Under the equity method, the parent accrues subsidiary earnings and amortization expense (from allocation of acquisition-date fair values) 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 opr other indefinite-lived assets). 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 a parent applies the initial value method, no accrual is recorded to reflect the subsidiary's change in book value subsequent to acquisition. Recognition of excess amortizations relating to the acquisition 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 employed in 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 acquirer applies the initial value method, changes in the subsidiary's book value in previous years are 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 to *C is needed when the parent applies the equity method. The parent will record changes in the subsidiary's book value as well as excess amortization each year. Thus, under the equity method, the parent's investment and beginning retained earnings balances are both correctly established and need no further adjustment.

6.

Lambert's loan payable and the receivable held by Jenkins are intra-entity accounts. The consolidation process offsets these reciprocal balances. The $100,000 is neither a debt to nor a receivable from an unrelated (or outside) party and is, therefore, not reported in consolidated financial statements. Any interest income/expense recognized on this loan is also intra-entity in nature and must likewise be eliminated.

7.

Because Benns applies the equity method, the $920,000 is composed of four balances: a. b. c. d.

The original consideration transferred by the parent; The annual accruals made by Benns to recognize subsidiary income as it is earned The reductions that are created by the subsidiary's payment of dividends The periodic amortization recognized by Benns in connection with the identified acquisition-date fair value allocations.

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.

9.

A parent should consider recognizing an impairment loss for goodwill associated with a subsidiary when, at the reporting unit level, the fair value is less than its carrying amount. A firm has the option to perform a qualitative assessment of whether a reporting unit’s fair value is more likely than not to be less than its carrying value before proceeding to the quantitative 2-step goodwill impairment testing procedure. Goodwill is reduced when

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10.

11.

its carrying value is less than its implied fair value. To compute an implied fair value for goodwill, the fair values of the reporting unit’s identifiable net assets are subtracted from its total fair value. The impairment is recognized as a loss from continuing operations. 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. 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 acquired. Push-down accounting uses the consideration transferred as the valuation basis for the subsidiary in consolidated reports. For example, if a piece of land costs Company B $10,000 but Company A allocates a $13,000 fair value to the land in 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, keeping 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 periodic amortization expense on those allocations with definite lives. Therefore, the subsidiary’s recorded income equals 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.

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Answers to Problems 1. A 2. B 3. A 4. D Willkom’s equipment book value—12/31/13....................... Szabo’s equipment book value—12/31/13 .......................... Original purchase price allocation to Szabo's equipment ($300,000 – $200,000) ........................................................... Amortization of allocation ($100,000 ÷ 10 years for 3 years) ................................... Consolidated equipment ......................................................

$210,000 140,000 100,000 (30,000) $420,000

5. A 6. B 7. D 8. B 9. B Phoenix revenues Phoenix expenses Net income before Sedona effect Equity income from Sedona Consolidated net income -orConsolidated revenues Consolidated expenses (includes $35K amortization) Consolidated net income

$498,000 350,000 148,000 55,000 $203,000 $783,000 580,000 $203,000

10. A (same as Phoenix because of equity method use). 11. C Consideration transferred at fair value Book value acquired Excess fair over book value to equipment to customer list (4 year life)

$600,000 420,000 180,000 80,000 $100,000

Three years since acquisition, ¼ of acquisition-date value ($25,000)remains. 12. B 13. C

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14. C The $60,000 excess acquisition-date fair value allocation to equipment is "pushed-down" to the subsidiary and increases its balance to $390,000. The consolidated balance is $810,000 ($420,000 plus $390,000). 15. (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—1/1/12 .................................. $400,000 Herbert income—2012 ................................................... 40,000 Herbert dividends—2012 (subsidiary dividends are intercompany and, thus, eliminated) ....................... (10,000) Rambis income—2012 (not included in parent's income) 20,000 Amortization—2012 ........................................................ (12,000) Herbert income—2013 ................................................... 50,000 Herbert dividends—2013 ................................................ (10,000) Rambis income—2013 ................................................... 30,000 Amortization—2013 ....................................................... (12,000) Consolidated retained earnings, 12/31/13 ..................... $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 less the dividends of the parent plus the income of the subsidiary less amortization expense. Thus, December 31, 2013 consolidated retained earnings are $496,000 as computed above.

b. Investment in Rambis—equity method Rambis fair value 1/1/12............................................................. $574,000 Rambis income 2012 .................................................................. 20,000 Rambis dividends 2012.............................................................. (5,000) Herbert’s 2012 excess fair over book value amortization ...... (12,000) Investment account balance 1/1/13 .......................................... $577,000 Investment in Rambis—partial equity method Rambis fair value 1/1/12............................................................. $574,000 Rambis income 2012 .................................................................. 20,000 Rambis dividends 2012.............................................................. (5,000) Investment account balance 1/1/12 .......................................... $589,000 Investment in Rambis—Initial value method Rambis fair value 1/1/12............................................................. $574,000 Investment account balance 1/1/13 .......................................... $574,000

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15. (continued) c.

ENTRY *C

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EQUITY METHOD No entry is needed to convert the past figures to the equity method since that method has already been applied.

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PARTIAL EQUITY METHOD Amortization for the prior years (only 2012 in this case) has not been recorded and must be brought into the consolidation through worksheet entry *C: ENTRY *C Retained Earnings, 1/1/13 (Parent) .................... 12,000 Investment in Rambis .................................... 12,000 (To record 2012 amortization in consolidated figures. Expense was omitted because of application of partial equity method.)

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INITIAL VALUE METHOD Amortization for the prior years (only 2012 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 2012). 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 Retained Earnings, 1/1/13 (Parent) ............... 3,000 (To record 2012 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, 2013 Retained Earnings balance equal to that of the equity method.

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16. (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) Book value equivalency ................................................. Excess of Turner fair value over book value ............... Excess fair value assigned to specific accounts based on fair value Equipment ......................... $5,000 Customer List ...................... 30,000

Life 5 yrs. 10 yrs.

$135,000 (100,000) $ 35,000 Annual excess amortizations $1,000 3,000 $4,000

Acquisition fair value ...................................................... 2012 Income accrual ...................................................... 2012 Dividends paid by Turner ..................................... 2012 Amortizations (above) ........................................... 2013 Income accrual ...................................................... 2013 Dividends paid by Turner ..................................... 2013 Amortizations ........................................................ Investment in Turner account balance .........................

$135,000 110,000 (50,000) (4,000) 130,000 (40,000) (4,000) $277,000

b. Net income of Haynes .................................................... Net Income of Turner ..................................................... Depreciation expense ..................................................... Amortization expense ..................................................... Consolidated net income 2013 ................................

$240,000 130,000 (1,000) (3,000) $366,000

c. Equipment balance Haynes ........................................... Equipment balance Turner ............................................ Allocation based on fair value (above) ......................... Depreciation for 2012-2013 ............................................ Consolidated equipment—December 31, 2013.............

$500,000 300,000 5,000 (2,000) $803,000

Parent's choice of an investment method has no impact on consolidated totals.

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16. (continued) d. If the initial value method was applied during 2012, the parent would have recorded dividend income of $50,000 rather than $110,000 (as equity income). Net income is, therefore, understated by $60,000. In addition, amortization expense of $4,000 was not recorded. Thus, the January 1, 2013, 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 ........................................... Retained Earnings, 1/1/13 (Haynes) .............

56,000 56,000

If the partial equity method was applied during 2012, 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, 1/1/13 (Haynes) ................... Investment in Turner .....................................

4,000 4,000

If the equity method was applied during 2012, the parent's retained earnings are the same as the consolidated figure so that no adjustment is necessary.

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17. (20 minutes) (Record a merger combination with 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 Fair value of shares issued Fair value consideration transferred

$450,000 1,248,000 $1,698,000

Consideration transferred (above) Fair value of net assets acquired and liabilities assumed Goodwill recognized in the combination

$1,698,000 1,298,000 $ 400,000

Entry by Francisco to record assets acquired and liabilities assumed in the 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 Long-term liabilities Cash Common stock (Francisco Co., par value) Additional paid-in capital

121,000 450,000 450,000 104,000 1,144,000

b. Step one in quantitative goodwill impairment test: Fair value of reporting unit as a whole Book value of reporting unit's net assets

1,425,000 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) 1,325,000 Implied fair value of goodwill 100,000 Book value of goodwill 400,000 Goodwill impairment loss $ 300,000

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18. (20 minutes) (Goodwill impairment testing.) a. Goodwill Impairment Step 1 Fair value of reporting unit = Carrying value of reporting unit =

$650 780

Because fair value < carrying value, there is a potential goodwill impairment loss. 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 Goodwill Customer list Patent

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$80 110 -0-0-

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19. (30 minutes) (Goodwill impairment and intangible assets.) Part a: Goodwill Impairment Test—Step 1

Sand Dollar Salty Dog Baytowne

Total fair value $510,000 580,000 560,000

< < >

Carrying Potential goodwill value impairment? $530,000 yes 610,000 yes 280,000 no

Part b: Goodwill Impairment Test—Step 2 (Sand Dollar and Salty Dog only) Sand Dollar—total fair value Fair values of identifiable net assets Tangible assets Trademark Customer list Liabilities Implied value of goodwill Carrying value of goodwill Impairment loss

$510,000 $190,000 150,000 100,000 (30,000)

Salty Dog—total fair value Fair values of identifiable net assets Tangible assets $200,000 Unpatented technology 125,000 Licenses 100,000 Implied value of goodwill Carrying value of goodwill No impairment—implied value > carry value

410,000 100,000 120,000 $20,000 $580,000

425,000 155,000 150,000 -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.

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20.

(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 amortizations Land .................................... $10,000 --Buildings ............................. 40,000 4 yrs. $10,000 Equipment ........................... (20,000) 5 yrs. (4,000) Total assigned to specific accounts ........................ Goodwill .............................. Total ....................................

30,000 60,000 $90,000

Indefinite

-0$6,000

Consolidation Entries as of December 31, 2012 Entry S Common Stock—Abernethy................................ 250,000 Additional Paid-in Capital—Abernethy............... 50,000 Retained Earnings—1/1/12 ................................. 100,000 Investment in Abernethy ............................... (To eliminate stockholders' equity accounts of subsidiary)

400,000

Entry A 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 goodwill). Entry I Equity in Earnings of Subsidiary ........................ 74,000 Investment in Abernethy ............................... 74,000 (To eliminate $80,000 income accrual for 2012 less $6,000 amortization recorded by parent using equity method)

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20. (continued) Entry D Investment in Abernethy .................................... Dividend Paid ................................................. (To eliminate intercompany dividend transfers) Entry E Depreciation Expense .......................................... Equipment............................................................. Buildings ......................................................... (To record current year amortization expense)

10,000 10,000

6,000 4,000 10,000

Consolidation Entries as of December 31, 2013 Entry S Common Stock—Abernethy ............................... 250,000 Additional Paid-in Capital—Abernethy .............. 50,000 Retained Earnings—1/1/13 .................................. 170,000 Investment in Abernethy ............................... 470,000 (To eliminate beginning stockholders' equity of subsidiary—the Retained Earnings account has been adjusted for 2012 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 (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 Earnings of Subsidiary ........................ 104,000 Investment in Abernethy ............................... 104,000 (To eliminate $110,000 income accrual less $6,000 amortization recorded by parent during 2013 using equity method) Entry D Investment in Abernethy .................................... Dividend Paid ................................................. (To eliminate intercompany dividend transfers)

30,000 30,000

Entry E Same as Entry E for 2012

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21.

(35 Minutes) (Consolidation entries for two years. Parent uses initial value method.) Purchase price allocation and annual excess fair value amortizations: Acquisition date value (consideration paid) ..... $500,000 Book value ........................................................... (400,000) Excess price paid over book value .................... $100,000 Excess price paid assigned to specific accounts based on fair values Equipment Long-term liabilities Goodwill Total

$ 20,000 30,000 50,000 $100,000

Life

Annual excess amortizations

5 yrs. 4 yrs. Indefinite

$4,000 7,500 -0$11,500

Consolidation entries as of December 31, 2012 Entry S Common Stock—Abernethy .............................. 250,000 Additional Paid-in Capital—Abernethy.............. 50,000 Retained Earnings—1/1/12 ................................ 100,000 Investment in Abernethy ............................... (To eliminate stockholders' equity accounts of subsidiary)

400,000

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) Entry I Dividend Income ................................................ 10,000 Dividends Paid .............................................. 10,000 (To eliminate intercompany dividend payments recorded by parent as income) Entry E Depreciation Expense ........................................ Interest Expense ................................................. Equipment ...................................................... Long-term Liabilities...................................... (To record 2012 amortization expense)

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4,000 7,500 4,000 7,500

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21. (continued) Consolidation Entries as of December 31, 2013 Entry *C Investment in Abernethy ................................... 58,500 Retained Earnings—1/1/13 (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—Abernethy.............. 50,000 Retained Earnings—1/1/13 ................................ 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 2012 income and dividends) Entry 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 2012

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22.

(20 Minutes) (Consolidation entries for two years. Parent uses partial equity method.) Fair value allocation and annual excess amortizations: Abernethy fair value (consideration paid) .............. Book value ................................................................ Excess fair value over book value (all goodwill) ...

$520,000 (400,000) $120,000

Life assigned to goodwill .........................................

Indefinite

Annual excess amortizations ..................................

-0-

Consolidation Entries as of December 31, 2012 Entry S Common Stock—Abernethy ............................... 250,000 Additional Paid-in Capital—Abernethy .............. 50,000 Retained Earnings—Abernethy—1/1/12 ............ 100,000 Investment in Abernethy ............................... (To eliminate stockholders' equity accounts of subsidiary)

400,000

Entry A Goodwill ............................................................... 120,000 Investment in Abernethy ............................... 120,000 (To recognize goodwill portion of the original acquisition fair value) Entry I Equity 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 .................................... Dividend Paid ................................................. (To eliminate intercompany dividend transfers)

10,000 10,000

Entry E—Not needed. Goodwill is not amortized. Consolidation Entries as of December 31, 2013 Entry *C—Not needed. Goodwill is not amortized. Entry S Common Stock—Abernethy................................ Additional Paid-in Capital—Abernethy............... Retained Earnings —Abernethy—1/1/13 ........... Investment in Abernethy ...............................

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250,000 50,000 170,000 470,000

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22. (continued) (To eliminate beginning of year stockholders' equity accounts of subsidiary—the retained earnings balance has been adjusted for 2012 income and dividends.) Entry A Goodwill ............................................................... Investment in Abernethy ............................... (To recognize original goodwill balance.)

120,000 120,000

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 .................................... Dividends Paid ............................................... (To eliminate Intercompany dividend transfers.)

30,000 30,000

Equity E—not needed 23.

(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' equity) ...................... 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 -0Total .......................................................... $10,000 Investment in Clay—December 31, 2013: Consideration transferred for Clay ............................... 2012: Equity accrual (based on Clay's Income) ............... Excess amortizations (above) ................................. Dividends received ................................................... 2013: Equity accrual (based on Clay's Income) ................ Excess amortizations ............................................... Dividends received ................................................... Total ................................................................................

McGraw-Hill/Irwin 3-18

$510,000 55,000 (10,000) (5,000) 60,000 (10,000) (8,000) $592,000

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

© The McGraw-Hill Companies, Inc., 2013 3-19

23. (continued) INITIAL VALUE METHOD Investment Income—2013: Dividend income ...........................................................

$8,000

Investment in Clay—December 31, 2013: Consideration transferred for Clay ...............................

$510,000

b. 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 the internal accounting method applied by Adams. c. 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 the internal accounting method applied by Adams. d. Adams retained earnings—Equity method Adams retained earnings—1/1/12 ....................................... Adams income 2012 ............................................................. 2012 equity in earnings of Clay (above) ............................. Adams retained earnings—1/1/13 .......................................

$860,000 125,000 45,000 $1,030,000

Adams retained earnings—Initial value method Adams retained earnings—1/1/12 ....................................... Adams income 2012 ............................................................. 2012 dividend income from Clay ........................................ Adams retained earnings—1/1/13 .......................................

$860,000 125,000 5,000 $990,000

e. EQUITY METHOD—Entry *C is unnecessary because the parent's retained earnings balance is correct. INITIAL VALUE METHOD—Entry *C recognizes the increase in subsidiary's book value ($55,000 income less 5,000 dividends) and amortization ($10,000) for prior year. Investment in Clay .............................................. Retained Earnings, 1/1/13 (parent) ...............

40,000 40,000

f. Consolidated worksheet entry S for 2013: Common Stock (Clay) .................................... Retained Earnings, 1/1/13 (Clay) ................... Investment in Clay ....................................

McGraw-Hill/Irwin 3-20

150,000 350,000 500,000

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual

23. (continued) g. Consolidated revenues (combined) .................. Consolidated expenses (combined plus excess amortization) ..................................... Consolidated net income .................................... 24.

$640,000 (480,000) $160,000

(15 Minutes) (Consolidated accounts one year after acquisition) Stanza acquisition fair value ($10,000 in stock issue costs reduce APIC ............ $680,000 Book value of subsidiary (1/1/13 stockholders' equity balances) ..... (480,000) Fair value in excess of book value .......... $200,000

Annual excess Excess fair value allocated to copyrights Life amortizations based on fair value .............................. 120,000 6 yrs. $20,000 Goodwill ..................................................... $ 80,000 indefinite -0Total ...................................................... $20,000

a. Consolidated copyrights Penske (book value) ...................................... $900,000 Stanza (book value) ....................................... 400,000 Allocation (above) .......................................... 120,000 Excess amortizations, 2013 .......................... (20,000) Total ........................................................... $1,400,000 b. Consolidated net income, 2013 Revenues (add book values) ........................ $1,100,000 Expenses: Combined book values ............................ $700,000 Excess amortizations ............................... 20,000 720,000 Consolidated net income ............................... $380,000 c. Consolidated retained earnings, 12/31/13 Retained Earnings 1/1/13 (Penske) ............... Net income 2013 (above) ............................... Dividend Paid 2013 (Penske) ........................ Total ...........................................................

$600,000 380,000 (80,000) $900,000

Stanza's January 1, 2013 retained earnings balance, is not included because they represent pre-acquisition earnings. Stanza's dividends paid to Penske are excluded because they are intra-entity in nature. d. Consolidated goodwill, 12/31/13 Allocation (above) ..........................................

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$80,000

© The McGraw-Hill Companies, Inc., 2013 3-21

25.

(30 Minutes) (Consolidated balances three years after the date of acquisition. Includes questions about parent's method of recording investment for internal reporting purposes.) a. Acquisition-Date Fair Value Allocation and Amortization: Consideration transferred 1/1/11 ............. Book value (given) .................................... Fair value in excess of book value ..... Allocation to equipment based on difference in fair value and book value ............................................ Goodwill ..................................................... Total ......................................................

$600,000 (470,000) 130,000

Annual excess Life amortizations

90,000 10 yrs. $40,000 indefinite

$9,000 -0$9,000

CONSOLIDATED BALANCES 

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



Dividend Paid = $120,000 (parent balance only. Subsidiary's dividends are eliminated as intra-entity 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])



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. 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 equity 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 (initial value method was employed) $1,100,000 Partial equity method—Foxx’s retained earnings—1/1/13

McGraw-Hill/Irwin 3-22

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual

25. (continued) 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 26.

(50 Minutes) (Consolidated totals for an acquisition. Worksheet is produced as a separate requirement.) a. O’Brien acquisition-date fair value .................... O’Brien book value ............................................. Fair value in excess of book value .................... Excess assigned to specific accounts based on fair value Trademarks .............................. Customer relationships ........... Equipment ................................ Goodwill ................................... Total ..........................................

$550,000 (350,000) $200,000

Annual excess amortizations $100,000 indefinite -075,000 5 yrs. $15,000 (30,000) 10 yrs. (3,000) 55,000 indefinite -0$200,000 $12,000 Life

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). 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)

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

© The McGraw-Hill Companies, Inc., 2013 3-23

26. (continued) 

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 subsidiary’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)



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



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



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)



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 consolidated balances)

McGraw-Hill/Irwin 3-24

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual

26. (Continued) c.

Accounts Revenues Cost of goods sold Depreciation expense Amortization expense Income of O’Brien Net income Retained earnings, 1/1 Net income (above) Dividends paid Retained earnings, 12/31 Cash Receivables Inventory Investment in O’Brien

Trademarks Customer relationships Equipment (net) Goodwill Total assets Liabilities Common stock Retained earnings (above) Total liabilities and equity

PATRICK COMPANY AND CONSOLIDATED SUBSIDIARY Consolidation Worksheet For Year Ending December 31 Consolidation Entries Patrick O’Brien Debit Credit (1,125,000) (520,000) 300,000 228,000 75,000 70,000 (E) 3,000 25,000 -0(E) 15,000 (210,000) -0(I) 210,000 (935,000) (222,000) (700,000) (935,000) 142,000 (1,493,000) 185,000 225,000 175,000 680,000

(250,000) (222,000) 80,000 (392,000)

(D) 80,000

105,000 56,000 135,000

60,000 -0272,000 -0628,000

(771,000) (400,000) (1,493,000) (2,664,000)

(136,000) (100,000) (392,000) (628,000)

(700,000) (935,000) 142,000 (1,493,000) 290,000 281,000 310,000

(D) 80,000

474,000 -0925,000 -02,664,000

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

(S) 250,000

Consolidated Totals (1,645,000) 528,000 142,000 40,000 -0(935,000)

(A) 100,000 (A) 75,000 (E) 3,000 (A) 55,000

(S) 350,000 (A) 200,000 (I) 210,000 (E) 15,000 (A) 30,000

(S) 100,000 888,000

888,000

© The McGraw-Hill Companies, Inc., 2013 3-25

-0634,000 60,000 1,170,000 55,000 2,800,000 (907,000) (400,000) (1,493,000) (2,800,000)

27.

(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 and annual amortization: a. Aaron fair value (stock exchanged at fair value) ....................................... Book value of subsidiary ....................... Excess fair value over book value ........

$470,000 (360,000) $110,000

Excess assigned to specific accounts based on fair values Life

Royalty agreements Trademark Total

$ 60,000 6 yrs. 50,000 10 yrs. $110,000

Annual excess amortizations

$10,000 5,000 $15,000

The parent company is apparently applying the initial value method: only dividend income is recognized during the current 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's retained earnings January 1, 2013 ....................... Retained earnings at date of acquisition .......................... Increase since date of acquisition ..................................... Excess amortization expenses ($15,000 x 4 years) .......... Conversion to equity method for years prior to 2013 (Entry *C) ...................................................................

$490,000 (230,000) $260,000 (60,000) $200,000

Explanations of consolidation worksheet entries 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 intra-entity dividends.

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

McGraw-Hill/Irwin 3-26

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual

27. a. (continued)

Accounts Revenues Cost of goods sold Amortization expense Dividend income Net income

MICHAEL COMPANY AND CONSOLIDATED SUBSIDIARY Consolidation Worksheet For Year Ending December 31, 2013 Consolidation Entries Michael Aaron Debit Credit (610,000) (370,000) 270,000 140,000 115,000 80,000 (E) 15,000 (5,000) -0(I) 5,000 (230,000) (150,000)

Retained earnings 1/1

(880,000)

(*C) 200,000

Net income (above) Dividends paid Retained earnings 12/31

(230,000) 90,000 (1,020,000)

(490,000) (150,000) 5,000 (635,000)

Cash Receivables Inventory Investment in Aaron Co.

$110,000 380,000 560,000 470,000

$15,000 220,000 280,000 -0-

Copyrights Royalty agreements Trademark Total assets

460,000 920,000 -02,900,000

340,000 380,000 -01,235,000

(780,000) (300,000) (500,000) (300,000) (1,020,000) (2,900,000)

(470,000) -0(100,000) (30,000) (635,000) (1,235,000)

Liabilities Preferred stock Common stock Additional paid-in capital Retained earnings 12/31 Total liabilities and equity

(S) 490,000 (I)

(*C) 200,000

(S) 620,000 (A) 50,000

(A) (A)

(E) 10,000 (E) 5,000

20,000 30,000

(S) 100,000 (S) 30,000 890,000

Parentheses indicate a credit balance.

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

5,000

© The McGraw-Hill Companies, Inc., 2013 3-27

890,000

Consolidated Totals (980,000) 410,000 210,000 -0(360,000) (1,080,000) -0(360,000) 90,000 (1,350,000) $125,000 600,000 840,000 -0800,000 1,310,000 25,000 3,700,000 (1,250,000) (300,000) (500,000) (300,000) (1,350,000) (3,700,000)

27. (continued) 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 (the 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 value 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 value 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 from the parent's income statement and from the Investment in Aaron Co. account. Entry D would eliminate the $5,000 current year dividend from Dividends Paid and the Investment in Aaron account balances. d. Consolidated figures are not affected by the investment 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.

McGraw-Hill/Irwin 3-28

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual

28.

(65 Minutes) (Consolidated totals and worksheet five years after acquisition. Parent uses equity method. Includes goodwill impairment.) a. Acquisition-date fair value allocations (given) Land Equipment Goodwill Total

$90,000 50,000 60,000 $200,000

Life

Annual excess amortizations --10 yrs. $5,000 indefinite -0$5,000

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 computed 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 Small = $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 balance)  Dividends paid = $310,000 (the parent number alone because the subsidiary's dividends are intra-entity, 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 consolidated dividends paid)  Current assets = $706,000 (both book balances are added together while the $10,000 intra-entity 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 acquisition-date fair value 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 acquisition-date fair value allocation [$50,000 less $25,000 after 5 years of excess depreciation])

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

© The McGraw-Hill Companies, Inc., 2013 3-29

28. 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)  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 Investment in Small

60,000 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.

McGraw-Hill/Irwin 3-30

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual

28. c. (continued) GIANT COMPANY AND SMALL COMPANY Consolidation Worksheet For Year Ending December 31, 2013 Accounts Revenues ............................................................ Cost of goods sold............................................. Depreciation expense ........................................ Equity income of Small ...................................... Net income ....................................................

Giant (1,175,000) 550,000 172,000 (135,000) (588,000)

Small (360,000) 90,000 130,000 -0(140,000)

Retained earnings 1/1 ........................................ Net income (above) ............................................ Dividends paid ................................................... Retained earnings 12/31 ..............................

(1,417,000) (588,000) 310,000 (1,695,000)

(620,000) (140,000) 110,000 (650,000)

Consolidation Entries Debit Credit

(E) 5,000 (I) 135,000

(S) 620,000 (D) 110,000

Current assets .................................................... Investment in Small ...........................................

398,000 995,000

318,000 -0-

Land ................................................................. Buildings (net) .................................................... Equipment (net).................................................. Goodwill.............................................................. Total assets ..................................................

440,000 304,000 648,000 -02,785,000

165,000 419,000 286,000 -01,188,000

(A) 90,000

Liabilities ............................................................ Common stock ................................................... Retained earnings (above) ................................ Total liabilities and equity............................

(840,000) (250,000) (1,695,000) (2,785,000)

(368,000) (170,000) (650,000) (1,188,000)

(P) 10,000 (S)170,000

(D) 110,000

(A) 30,000 (A) 60,000

1,230,000

Parentheses indicate a credit balance.

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

© The McGraw-Hill Companies, Inc., 2013 3-31

(P) 10,000 (S) 790,000 (A) 180,000 (I) 135,000

(E)

5,000

1,230,000

Consolidated Totals (1,535,000) 640,000 307,000 -0(588,000) (1,417,000) (588,000) 310,000 (1,695,000) 706,000 -0-

695,000 723,000 959,000 60,000 3,143,000 (1,198,000) (250,000) (1,695,000) (3,143,000)

29. (45 Minutes) (Consolidated totals and worksheet two years after acquisition. Parent uses initial value method. Includes question comparing initial value and equity methods). a. 12/31/2013 Sales Cost of goods sold Interest expense Depreciation expense Amortization expense Dividend income Net Income

Pinnacle (7,000,000) 4,650,000 255,000 585,000 (50,000) (1,560,000)

(190,000)

Retained earnings 1/1/13 Net income Dividends paid Retained earnings 12/31/13

(5,000,000) (1,560,000) 560,000 (6,000,000)

(1,350,000) (190,000) 50,000 (1,490,000)

Cash Accounts receivable Inventory Investment in Strata

433,000 1,210,000 1,235,000 3,200,000

165,000 200,000 1,500,000

Buildings (net) Licensing agreements Goodwill Total Assets

5,572,000

2,040,000 1,800,000

Accounts payable Long-term debt Common stock - Pinnacle Common stock - Strata Retained earnings 12/31/13 Total Liabilities and OE

350,000 12,000,000 (300,000) (2,700,000) (3,000,000) (6,000,000) (12,000,000)

Strata (3,000,000) 1,700,000 160,000 350,000 600,000

Adjustments and Eliminations

E

30,000

D

50,000

S 1,350,000

E

20,000

*C

240,000

D

50,000

P

85,000

*C

240,000

S 2,850,000 A 590,000

A E A

270,000 20,000 400,000

E A

(715,000) (2,000,000)

P

85,000

(1,500,000) (1,490,000) (5,705,000)

S 1,500,000

30,000 80,000

5,705,000

3,945,000

3,945,000

Consolidated (10,000,000) 6,350,000 415,000 965,000 580,000 0 (1,690,000) (5,240,000) (1,690,000) 560,000 (6,370,000) 598,000 1,325,000 2,735,000 0

7,852,000 1,740,000 750,000 15,000,000 (930,000) (4,700,000) (3,000,000) 0 (6,370,000) (15,000,000)

b. Subsidiary income (190,000 – 10,000) ...................................... $180,000 1/1/13 retained earnings (5,000,000 + 240,000) .................... $5,240,000 Investment in Strata: Initial value basis ............................................................ $3,200,000 Conversion to equity as of 1/1/13 $240,000 Income for 2013 180,000 Dividends for 2013 (50,000) 370,000 Equity method balance 12/31/13 ..................................... $3,570,000 c. The internal method choice for investment accounting has no effect on consolidated financial statements. McGraw-Hill/Irwin 3-32

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual

30. (30 Minutes) (Determine consolidated accounts and consolidation entries five years after purchase. Parent applies equity method.) a. Fair value allocation and annual amortization

Land .......................................... Buildings ........................................ Equipment ...................................... Customer List ................................. Total ..........................................

Allocation $20,000 (30,000) 60,000 100,000

Life 10 yrs. 5 yrs. 20 yrs.

Annual excess amortizations $(3,000) 12,000 5,000 $14,000

CONSOLIDATED TOTALS  Revenues = $850,000 (add the two book values)  Cost of goods 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 acquisitiondate fair value allocation [a $30,000 reduction] after removing 5 years of amortization totaling $15,000)  Equipment (net) = $450,000 (add the two book values. The acquisition-date fair value 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.)

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

© The McGraw-Hill Companies, Inc., 2013 3-33

30. (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 enter 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 ................................ (To remove intra-entity dividend payments)

40,000

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)

McGraw-Hill/Irwin 3-34

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual

31.

(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 ............. Santiago book value (given) .......... Technology undervaluation (6 yr. life) Acquisition fair value of net assets Gain on bargain purchase ..............

$1,090,000 $950,000 240,000 1,190,000 $(100,000)

Santiago income .............................. Technology amortization ................ Equity earnings in Santiago ...........

$(200,000) 40,000 $(160,000)

Fair value of net assets at acquisition-date Equity earnings from Santiago....... Dividends received .......................... Investment in Santiago 12/31/13 ....

$1,190,000 160,000 (50,000) $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.

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

© The McGraw-Hill Companies, Inc., 2013 3-35

31 b. Peterson and Subsidiary Consolidated Worksheet For the Year Ended December 31, 2013 Income Statement Revenues Cost of goods sold Gain on bargain purchase Depreciation and amortization Equity earnings in Santiago Net income Statement of Retained Earnings Retained earnings, 1/1 Net income (above) Dividends paid Retained earnings, 12/31 Balance Sheet Current assets Investment in Santiago

Trademarks Patented technology Equipment Total assets Liabilities Common stock Retained earnings, 12/31 Total liabilities and equity

McGraw-Hill/Irwin 3-36

Peterson (535,000) 170,000 (100,000)

Santiago (495,000) 155,000 -0-

Adj. &

125,000 (160,000) (500,000)

140,000 -0(200,000)

(E) 40,000 (I) 160,000

305,000 -0(500,000)

(1,500,000) (500,000) 200,000 (1,800,000)

(650,000) (200,000) 50,000 (800,000)

(S) 650,000

(1,500,000) (500,000) 200,000 (1,800,000)

190,000 1,300,000

300,000 -0-

100,000 300,000 610,000 2,500,000

200,000 400,000 300,000 1,200,000

(165,000) (535,000) (1,800,000) (2,500,000)

(100,000) (300,000) (800,000) (1,200,000)

Elim.

(D) 50,000

Consolidated (1,030,000) 325,000 (100,000)

490,000 (D) 50,000

(A) 240,000

(I) 160,000 (S) 950,000 (A) 240,000 (E) 40,000

(S) 300,000 1,440,000

1,440,000

-0300,000 900,000 910,000 2,600,000 (265,000) (535,000) (1,800,000) (2,600,000)

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual

32. (35 minutes) (Contingent performance obligation and worksheet adjustments for equity and initial value methods.) a. 1/1/12 Investment in Wolfpack, Inc. 500,000 Contingent Performance Obligation 35,000 Cash 465,000 b.12/31/12 Loss from Increase in Contingent Performance Obligation 5,000 Contingent Performance Obligation 5,000 12/31/13 Loss from Increase in Contingent Performance Obligation 10,000 Contingent Performance Obligation 10,000 12/31/13 Contingent Performance Obligation Cash

50,000 50,000

c. Equity Method Worksheet Adjustments Common Stock- Wolfpack Retained Earnings-Wolfpack Investment in Wolfpack

200,000 180,000 380,000

Royalty Agreements Goodwill Investment in Wolfpack

90,000 60,000

Equity Earnings of Wolfpack Investment in Wolfpack

65,000

Investment in Wolfpack Dividends Paid

35,000

Amortization Expense Royalty Agreements

10,000

150,000

65,000

35,000

10,000

Investment account after worksheet adjustments = (560,000 – 380,000 – 150,000 – 65,000 + 35,000) = 0 d. Initial Value Method Investment in Wolfpack Retained Earnings-Branson Common Stock- Wolfpack Retained Earnings-Wolfpack Investment in Wolfpack

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

30,000 30,000 200,000 180,000 380,000**

© The McGraw-Hill Companies, Inc., 2013 3-37

32. (continued) Royalty Agreements Goodwill Investment in Wolfpack

90,000 60,000

Dividend Income Dividends Paid

35,000

Amortization Expense Royalty Agreements

10,000

150,000

35,000

10,000

33. (45 Minutes) (Prepare consolidation worksheet five years after acquisition. Parent applies equity method. Includes question on push-down accounting.) a. Allocation of Acquisition-Date Fair Value and Amortization: Storm’s acquisition-date fair value .................... Book value of Storm (acquisition date) ............. Fair value in excess of book value ....................

$140,000 (105,000) $ 35,000

Excess assigned to specific accounts: Life

Land ........................................... Equipment ................................. Formula ...................................... Total ................................................

$10,000 5,000 20,000 $35,000

Annual excess amortizations

– 5 yrs. 20 yrs.

– $1,000 1,000 $2,000

The equity in subsidiary earnings account reflects the equity method. The initial value method would have entered $40,000 (100% of dividend 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 expenses 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—Enters remaining unamortized allocation from acquisition-date fair value adjustments. As of the beginning of the current year, equipment and formula have undergone four years of amortization. Entry I—Eliminates subsidiary income accrual for the current year. Entry D—Eliminates intra-entity dividend transfers. Entry E—Recognizes excess amortization expenses for current year.

McGraw-Hill/Irwin 3-38

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual

33. (continued) Palm and Subsidiary Consolidated Worksheet for the year ended December 31, 2013 Accounts Income Statement Revenues .......................................................... Cost of goods sold........................................... Depreciation expense ...................................... Amortization expense ...................................... Equity in subsidiary earnings ......................... Net income ..................................................

Palm Co.

Storm Co.

Consolidation Entries Debit Credit

Consolidated Totals

(485,000) 160,000 130,000 -0(66,000) (261,000)

(190,000) 70,000 52,000 (E) 1,000 -0- (E) 1,000 -0- (I) 66,000 (68,000)

(675,000) 230,000 183,000 1,000 -0(261,000)

Statement of Retained Earnings Retained earnings 1/1 ...................................... Net income (above) .......................................... Dividends paid ................................................. Retained earnings 12/31 ............................

(659,000) (261,000) 175,500 (744,500)

(98,000) (S) 98,000 (68,000) 40,000 (126,000)

(659,000) (261,000) 175,500 (744,500)

Balance Sheet Current assets .................................................. Investment in Storm Co. ..................................

268,000 216,000

75,000 -0-

Land ............................................................... Buildings and equipment (net) ........................ Formula............................................................. Total assets ................................................

427,500 713,000 -01,624,500

58,000 161,000 -0294,000

Current liabilities.............................................. Long-term liabilities ......................................... Common stock ................................................. Additional paid-in capital................................. Retained earnings 12/31 .................................. Total liabilities and equity.......................... Parentheses indicate a credit balance.

(110,000) (80,000) (600,000) (90,000) (744,500) (1,624,500)

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

(D) 40,000

(A) 10,000 (A) 1,000 (A) 16,000

(D)

40,000

(S) 163,000 (A) 27,000 (I) 66,000 (E) (E)

(19,000) (84,000) (60,000) (S) 60,000 (5,000) (S) 5,000 (126,000) (294,000) 298,000

© The McGraw-Hill Companies, Inc., 2013 3-39

1,000 1,000

298,000

343,000 -0-

495,500 874,000 15,000 1,727,500 (129,000) (164,000) (600,000) (90,000) (744,500) (1,727,500)

33. (continued) c. If push-down accounting had been applied, the acquisition=date fair value allocations to land ($10,000), equipment ($5,000), and formula ($20,000) would have been entered into the subsidiary's balances with an offsetting $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 income 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. However, 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. 34. has

(20 Minutes) (Consolidated balances three years after acquisition. Parent 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 Equipment ................................. Buildings (overvalued) ............. Goodwill ..................................... Total ...........................................

Annual excess Life amortization $54,400 8 yrs. $6,800 (10,000) 20 yrs. (500) $21,600 indefinite -0$6,300

Investment in Jasmine Company—12/31/13 Jasmine’s acquisition-date fair value ............................ 2010 Increase in book value of subsidiary ................... 2010 Excess amortizations (Schedule 1) ..................... 2011 Increase in book value of subsidiary ................... 2011 Excess amortizations (Schedule 1) ..................... 2012 Increase in book value of subsidiary ................... 2012 Excess amortizations (Schedule 1) ..................... Investment in Jasmine Company 12/31/13 ..............

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$206,000 40,000 (6,300) 20,000 (6,300) 10,000 (6,300) $257,100

© The McGraw-Hill Companies, Inc., 2013 3-41

34. (continued) b. Equity in subsidiary earnings Income accrual ................................................................ Excess amortizations (Schedule 1) .............................. Equity in subsidiary earnings ..................................

$30,000 (6,300) $23,700

c. Consolidated net income Consolidated revenues (add book values) .................. Consolidated expenses (add book values) .................. Excess amortization expenses (Schedule 1) ............... Consolidated net income ...............................................

$414,000 (272,000) (6,300) $135,700

d. Consolidated equipment Book values added together ......................................... Allocation of acquisition-date fair value ...................... Excess depreciation ($6,800 × 3) .................................. Consolidated equipment ..........................................

$370,000 54,400 (20,400) $404,000

e. Consolidated buildings................................................... Book values added together ......................................... Allocation of acquisition-date fair value ...................... Excess depreciation ($500 × 3) ..................................... Consolidated buildings .............................................

$288,000 (10,000) 1,500 $279,500

f. Consolidated goodwill Allocation of excess fair value to goodwill ...................

$21,600

g. Consolidated common stock .........................................

$290,000

As an acquisition, 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. 35.

(35 minutes) (Consolidation with IPR&D, equity method)

a.

Consideration transferred 1/1/12 Increase in Salsa’s retained earnings to1/1/13 In-process R&D write-off in 2012 Amortizations 2012 Income 2013 Dividends paid 2013 Amortization 2013 Investment balance 12/31/13

McGraw-Hill/Irwin 3-42

$1,765,000 150,000 (44,000) (7,000) 210,000 (25,000) (7,000) $2,042,000

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual

35. (continued) b.

Picante and Subsidiary Salsa Consolidated Worksheet For the Year Ended December 31, 2013

Accounts Sales Cost of goods sold Depreciation expense Subsidiary income Net Income

12/31/13 Picante (3,500,000) 1,600,000 540,000 (203,000) (1,563,000)

12/31/13 Salsa (1,000,000) 630,000 160,000

Retained earnings 1/1/13 Net Income Dividends paid Retained earnings 12/31/13

(3,000,000) (1,563,000) 200,000 (4,363,000)

(800,000) (210,000) 25,000 (985,000)

228,000 840,000 900,000 2,042,000

50,000 155,000 580,000

Land Equipment (net) Goodwill Total assets

3,500,000 5,000,000 290,000 12,800,000

700,000 1,700,000 -03,185,000

Accounts payable Long-term debt Common stock—Picante Common stock—Salsa Retained earnings 12/31/13

(193,000) (3,094,000) (5,150,000)

Cash Accounts receivable Inventory Investment in Salsa

(4,363,000) (12,800,000)

Adjustments

Consolidated (4,500,000) 2,230,000 707,000 -0(1,563,000)

(E) 7,000 (I) 203,000

(210,000) (S) 800,000 (D)

(D) 25,000

(A) 49,000 (A) 15,000

25,000

(S)1,800,000 (A) 64,000 (I) 203,000 (E)

7,000

(400,000) (800,000) (1,000,000) (985,000) (3,185,000)

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

(3,000,000) (1,563,000) 200,000 (4,363,000) 278,000 995,000 1,480,000 -0-

4,200,000 6,742,000 305,000 14,000,000 (593,000) (3,894,000) (5,150,000)

(S)1,000,000 2,099,000

2,099,000

(4,363,000) (14,000,000)

© The McGraw-Hill Companies, Inc., 2013 3-43

36.

(55 minutes) (Goodwill impairment, consolidated balances, and worksheet) a. Prine compares 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 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 Fair values of assets and liabilities Cash Receivables (net) Movie library Broadcast licenses Equipment Current liabilities Long-term debt Total net fair value Implied fair value for goodwill Carrying value for goodwill Impairment loss Journal Entry by Prine: Goodwill impairment loss Investment in Lydia Co.

$110,000,000 $109,000 897,000 60,000,000 20,000,000 19,000,000 (650,000) (6,250,000) 93,106,000 16,894,000 50,000,000 $33,106,000

33,106,000 33,106,000

c. Combined revenues $30,000,000 Combined expenses (including excess amortization) 22,200,000 Income before impairment loss 7,800,000 Goodwill impairment loss—Lydia (33,106,000) Net loss $(25,306,000) d. Consolidated goodwill = $50,000,000 – $33,106,000 = $16,894,000 e. Consolidated broadcast licenses = $350,000 + $14,014,000 = $14,364,000 The consolidated balance is the parent’s book value plus the fair value of the subsidiary acquisition-date value adjusted for changes since acquisition. Because the subsidiary’s book value equaled fair value at acquisition date, there is no fair value adjustment. Because the broadcast licenses 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. McGraw-Hill/Irwin 3-44

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual

36. f. (continued)

Prine and Lydia Consolidated Worksheet December 31

Accounts Revenues Expenses Equity in Lydia earnings Impairment loss Net income/loss

Prine, Inc. (18,000,000) 10,350,000 (150,000) 33,106,000 25,306,000

Retained earnings 1/1 Dividends paid Net income Retained earnings 12/31

(52,000,000) 300,000 25,306,000 (26,394,000)

Cash Receivables (net) Investment in Lydia, Co.

260,000 210,000 86,964,000

Broadcast licenses Movie library Equipment (net) Goodwill Total assets Current liabilities Long-term debt Common stock Retained earnings 12/31 Total liabilities and equity

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

Lydia Co. (12,000,000) 11,800,000 (E) -0- (I) -0(200,000)

Adjusting Entries Debit Credit 50,000 150,000

(2,000,000) (S) 2,000,000 80,000 (200,000) (2,120,000) 109,000 897,000 -0- (D)

80,000

350,000 365,000 136,000,000 -0224,149,000

14,014,000 45,000,000 17,500,000 (A) 500,000 -0- (A)16,894,000 77,520,000

(755,000) (22,000,000) (175,000,000) (26,394,000) (224,149,000)

(650,000) (7,250,000) (67,500,000) (S)67,500,000 (2,120,000) (77,520,000) 87,114,000

(D)

80,000

(S)69,500,000 (A)17,394,000 (I) 150,000

(E)

(52,000,000) 300,000 25,306,000 (26,394,000) 369,000 1,107,000 -0-

14,364,000 45,365,000 50,000 153,950,000 16,894,000 232,049,000

87,114,000

© The McGraw-Hill Companies, Inc., 2013 3-45

Consolidated Totals (30,000,000) 22,200,000 -033,106,000 25,306,000

(1,405,000) (29,250,000) (175,000,000) (26,394,000) (232,049,000)

RESEARCH CASE SOLUTION Jonas recognized several identifiable intangibles from its acquisition of Innovation Plus. 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 allocating 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 amortized; 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 (ASC 350-30-35-3). The price paid by Jonas for Innovation Plus indicates a large amount was paid for goodwill. However, Jonas worries that any goodwill impairment may send the wrong signal to its investors about the wisdom of the 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. 4. Per the FASB ASC (350-20-35-41): 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. Therefore, Jonas’ desire to minimize the possibility of goodwill impairment should not be a factor in allocating goodwill to reporting units. McGraw-Hill/Irwin 3-46

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual

Nike Research Case Solution—Goodwill Impairment 1) Nike reported a $199.3 million goodwill impairment charge in 2009 2) Nike wrote down its goodwill in because ―as a result of a significant decline in global consumer demand and continued weakness in the macroeconomic environment, as well as decisions by Company management to adjust planned investment in the Umbro brand, the Company concluded that sufficient indicators of impairment existed to require the performance of an interim assessment of Umbro's goodwill and indefinite lived intangible assets as of February 1, 2009.‖ (Nike 2009 10-K Note 4) FASB ASC 350-20-35-3C provides the following examples as possible interim triggering events in assessing potential goodwill impairment:  Macroeconomic conditions  Industry and market considerations  Cost factors having negative effect on earnings and cash flows  Overall financial performance 3) Consolidated Balance Sheets: Goodwill down from $448.8 in 2008 to $193.5 in 2009 (in millions) from Umbro impairment and miscellaneous other charges. Consolidated Statement of Operations: Goodwill impairment: $199.3 million Consolidated Statement of Cash Flows: Goodwill and other impairments: $401.3 million 4) Nike reviews its goodwill for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Testing Steps (assuming adecision to forego the option of first performing a qualitative analysis:  First step: compare the fair value of their Umbro reporting unit with its net book value. If the fair value of the Umbro reporting unit exceeds its net book value, goodwill is not impaired, and no further testing is necessary. If the net book value of the Umbro reporting unit exceeds its fair value, a second test is performed.  Second step: compare the implied fair value of goodwill with that recorded on the balance sheet. Implied fair value of goodwill is determined in the same manner as if the Umbro reporting unit were being acquired in a business combination. Specifically, fair value of the Umbro reporting 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 implied fair value of goodwill is less than the goodwill recorded on their balance sheet, an impairment charge is recorded for the difference.

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

© The McGraw-Hill Companies, Inc., 2013 3-47

5) Nike incurred a $202 million impairment charge for its long-lived assets in 2009, primarily attributable to Umbro’s trademark and an equity investment owned by Umbro. Nike (2009 10-K p. 46) 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). Nike (2009 10-K p. 45) reviews its long-lived assets (including intangible assets with a finite life) for impairment whenever events or changes in circumstances indicate that the carrying amount might not be recoverable. The assets are impaired if the total of the projected 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).

McGraw-Hill/Irwin 3-48

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual

FASB ASC AND IASB RESEARCH CASE 1. GAAP prohibits reversal of impairment losses for goodwill. prohibits reversal of impairment losses for goodwill.

IFRS also

2. Requirements for goodwill impairment differ under IFRS. Under IFRS, goodwill impairment testing uses 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 amount. An impairment loss is recognized in operating results as the excess of carrying over the recoverable amount. The impairment loss is allocated first to goodwill and then pro rata to the other assets of the CGU or group of CGUs to the extent that the impairment exceeds goodwill’s book value. 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 unit may be impaired, by comparing the carrying amount of the unit, including the goodwill, with the recoverable amount 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.

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

© The McGraw-Hill Companies, Inc., 2013 3-49

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

Revenues Cost of good sold Depreciation expense Amortization expense Dividend income Net Income Retained earnings 1/1 Net income Dividends paid Retained earnings 12/31 Current assets Investment in Chiptech

Innovus (990,000) 500,000 100,000 55,000 (40,000) (375,000)

ChipTech (210,000) 90,000 5,000 18,000 -0(97,000)

(1,555,000) (375,000) 250,000 (1,680,000)

(450,000) (97,000) 40,000 (507,000)

960,000 670,000

355,000

Adjustments

(E) 20,000 (I) 40,000

(S)450,000

(*C) 60,000 (I) 40,000

Liabilities Common stock Additional paid-in capital Retained earnings 12/31 Total liabilities and equity

McGraw-Hill/Irwin 3-50

(1,615,000) (412,000) 250,000 (1,777,000) 1,315,000

(*C) 60,000 (S) 580,000 (A) 150,000

Equipment (net) Trademark Existing technology Goodwill Total assets

Consolidated (1,200,000) 590,000 105,000 93,000 -0(412,000)

765,000 235,000 0 450,000 3,080,000

225,000 100,000 45,000 -0725,000

(780,000) (500,000) (120,000) (1,680,000) (3,080,000)

(88,000) (100,000) (30,000) (507,000) (725,000)

(A) 36,000 (A) 64,000 (A) 50,000

(E) 4,000 (E) 16,000

(S)100,000 (S) 30,000 850,000

850,000

-0990,000 367,000 93,000 500,000 3,265,000 (868,000) (500,000) (120,000) (1,777,000) (3,265,000)

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual

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

Revenues Cost of good sold Depreciation expense Amortization expense Impairment loss Dividend income Net Income Retained earnings 1/1 Net income Dividends paid Retained earnings 12/31 Current assets Investment in Chiptech

Innovus (990,000) 500,000 100,000 55,000 50,000 (40,000) (325,000)

ChipTech (210,000) 90,000 5,000 18,000 -0(97,000)

(I) 40,000

(1,555,000) (325,000) 250,000 (1,630,000)

(450,000) (97,000) 40,000 (507,000)

(S)450,000

960,000 620,000

355,000

Consolidated (1,200,000) 590,000 105,000 93,000 50,000 -0(362,000)

(E) 20,000

(*C) 60,000 (I) 40,000

(1,615,000) (362,000) 250,000 (1,727,000) 1,315,000

(*C) 60,000 (S)580,000 (A)100,000

Equipment (net) Trademark Existing technology Goodwill Total assets

765,000 235,000 -0450,000 3,030,000

225,000 100,000 45,000 -0725,000

Liabilities Common stock Additional paid-in capital Retained earnings 12/31 Total liabilities and equity

(780,000) (500,000)

(88,000) (100,000)

(120,000) (1,630,000)

(30,000) (507,000)

(S) 30,000

(3,030,000)

(725,000)

800,000

(A) 36,000 (A )64,000

(E) 4,000 (E) 16,000

-0990,000 367,000 93,000 450,000 3,215,000 (868,000) (500,000)

(S)100,000

(120,000) (1,727,000) 800,000

(3,215,000)

Alternatively, the goodwill impairment loss could have been recorded as an adjustment on the worksheet.

McGraw-Hill/Irwin Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

© The McGraw-Hill Companies, Inc., 2013 3-51

Excel Case 2 Solution Part a: Investment in Wi-Free account balance 12/31/13 Wi-Free’s acquisition-date fair value Change in Wi-Free’s retained earnings for 2012 2012 amortization 2012 in-process R&D write-off 2013 reported Wi-Free income 2013 Wi-Free dividend 2013 amortization Balance 12/31/13 Part b:

$730,000 80,000 (4,500) (75,000) 180,000 (50,000) (4,500) $856,000 Consolidation Entries Debit Credit

Consolidated Totals (1,425,000) 747,000 152,000 7,500 65,500

Hi-Speed (1,100,000) 625,000 140,000 50,000

Wi-Free (325,000) 122,000 12,000 11,000

(175,500) (460,500)

-0(180,000)

(I) 175,500

-0(460,500)

(1,552,500) (460,500) 250,000 (1,763,000)

(450,000) (180,000) 50,000 (580,000)

(S)450,000

(1,552,500) (460,500) 250,000 (1,763,000)

Current assets Investment in Wi-Free

1,034,000 856,000

345,000

Equipment (net) Computer software Internet domain name Goodwill Total assets

713,000 650,000 -0-03,253,000

305,000 130,000 100,000 -0880,000

(870,000) (500,000) (120,000) (1,763,000) (3,253,000)

(170,000) (110,000) (20,000) (580,000) (880,000)

Revenues Cost of goods sold Depreciation expense Amortization expense Equity in subsidiary earnings Net Income Retained earnings 1/1 Net income Dividends paid Retained earnings 12/31

Liabilities Common stock Additional paid-in capital Retained earnings 12/31 Total liab. and equity

McGraw-Hill/Irwin 3-52

(E) 12,000

(E)

(D) 50,000

(D) 50,000

(E) 7,500 (A)108,000 (A) 65,000

(P) 30,000 (I) 175,500 (S)580,000 (A)150,500 (A) 22,500 (E) 12,000

(P) 30,000 (S)110,000 (S) 20,000 1,028,000

1,028,000

1,349,000

0 1,018,000 765,000 196,000 65,000 3,393,000 (1,010,000) (500,000) (120,000) (1,763,000) (3,393,000)

© The McGraw-Hill Companies, Inc., 2013 Solutions Manual