Advanced Accounting
by Debra Jeter and Paul Chaney
Chapter 5: Allocation, Depreciation,
and Amortization of the Difference
between Cost and Book Value
Slides Authored by Hannah Wong, Ph.D.
Rutgers University
5-0
Allocation of Purchase Differential
Book value of
net assets
acquired
Acquisition
cost
Purchase
differential
(MV-BV) of
identifiable
net assets
Goodwill
(if amount >0)
or bargain purchase
(if amount <0)
5-1
Allocation of Purchase Differential:
An Alternative View
Book value of
net assets
acquired
Acquisition
cost
(MV-BV) of
identifiable
net assets
Goodwill
(if amount >0)
or bargain purchase
(if amount <0)
Market value of
net assets
acquired
Goodwill
(if amount >0)
or bargain purchase
(if amount <0)
5-2
Bargain Purchase
Valuation of Net Assets Acquired:
 Current assets, long-term investments in marketable
securities, liabilities = fair value
 Previously recorded goodwill = 0
 Long-term assets = fair value - bargain allocation
(The bargain is allocated to long-term assets in proportion
to their fair value.)
 Any remaining bargain is recorded as negative goodwill and
amortized over a maximum of 40 years.
5-3
Case 1: Positive Goodwill
Wholly Owned Subsidiary
Acquisition
cost
$2,750,000
Book value of
net assets
acquired
$2,000,000
Inventory $50,000
Purchase
differential
$750,000
Equipment $300,000
Land $150,000
Goodwill
$250,000
5-4
Case 1: Positive Goodwill
80% Owned Subsidiary
Acquisition
cost
$2,200,000
Book value of
net assets
acquired
$1,600,000
Note: identifiable net
assets are written up
only by :
P% x (MV-BV)
Inventory $40,000
Purchase
differential
$600,000
Equipment $240,000
Land $120,000
Goodwill
$200,000
5-5
Case 1: Positive Goodwill - EE’s
The Investment Entry
Retained earnings - S
Capital stock - S
Difference between cost and book value
Investment in S
400,000
1,200,000
600,000
2,200,000
The Allocation Entry
Inventory
Equipment
Land
Goodwill
Difference between cost and book value
40,000
240,000
120,000
200,000
600,000
5-6
Case 2A: Bargain Purchase
BV < Cost
80% Owned Subsidiary
Acquisition
cost
$1,900,000
Book value of
net assets
acquired
$1,600,000
Note: identifiable net
assets are written up
only by :
P% x (MV-BV)
Inventory $40,000
Equipment $240,000
Purchase
differential
$300,000
Land $120,000
Bargain purchase
$100,000
5-7
Case 2A: Bargain Purchase
BV < Cost
Allocation of Bargain Purchase
Note: assets are reduced
in proportion to their fair
values, not book values
Reduction in asset
amounts:
Equipment $30,000
Bargain purchase
$100,000
Land $20,000
Other noncurrent
assets $50,000
5-8
Case 2A: Bargain Purchase
BV < Cost : EE’s
The Investment Entry
Retained earnings - S
Capital stock - S
Difference between cost and book value
Investment in S
400,000
1,200,000
300,000
1,900,000
The Allocation Entry
Inventory
Equipment (240,000-30,000)
Land (120,000-20,000)
Other noncurrent assets (0-50,000)
Difference between cost and book value
40,000
210,000
100,000
50,000
300,000
5-9
Case 2B: Bargain Purchase
BV > Cost
80% Owned Subsidiary
Acquisition
cost
$1,500,000
Book value of
net assets
acquired
$1,600,000
Note: identifiable net
assets are written up
only by :
P% x (MV-BV)
Inventory $40,000
Equipment $240,000
Purchase
differential
-$100,000
Land $120,000
Bargain purchase
$500,000
5 - 10
Case 2B: Bargain Purchase
BV > Cost
Allocation of Bargain Purchase
Note: assets are reduced
in proportion to their fair
values, not book values
Reduction in asset
amounts:
Equipment $150,000
Bargain purchase
$500,000
Land $100,000
Other noncurrent
assets $250,000
5 - 11
Case 2B: Bargain Purchase
BV > Cost : EE’s
The Investment Entry
Retained earnings - S
400,000
Capital stock - S
1,200,000
Difference between cost and book value
100,000
Investment in S
1,500,000
The Allocation Entry
Difference between cost and book value
Inventory
Equipment (240,000-150,000)
Land (120,000-100,000)
Other noncurrent assets (0-250,000)
100,000
40,000
90,000
20,000
250,000
5 - 12
Amortization of Purchase Differential
Case 1: Positive Goodwill, 80% Owned Subsidiary
Purchase
differential
Annual adjustments to consolidated NI
2001
2002-2010
2011-2020
Inventory
$40,000
$40,000
Inventory
Inventory$40,000
$40,000 Inventory
Inventory
COGS $40,000
$40,000
Inventory
$40,000
Equipment
$240,000
Depreciation
expense
$24,000
Depreciation
expense
$24,000
Land
$120,000
Goodwill
$200,000
Amortization
expense
$10,000
Amortization
expense
$10,000
Amortization
expense
$10,000
5 - 13
Amortization of Purchase Differential
Case 1: Positive Goodwill, 80% Owned Subsidiary
Annual adjustments to beginning consolidated R/E
2001
COGS $40,000
Consolidated
NI
adjustments
Depreciation
expense
$24,000
Amortization
expense
$10,000
Adjustments
to 1/1 R/E
= sum of NI
adjustments in
all previous
years
0
2001
2002
Depreciation
expense
$24,000
Depreciation
expense
$24,000
Amortization
expense
$10,000
Amortization
expense
$10,000
74,000
108,000
5 - 14
The Allocation EE
Cost Method
End of Year of Acquisition
Cost of goods sold
Depreciation expense
Amortization expense of goodwill
Equipment
Land
Goodwill
Difference between cost and book value
40,000
24,000
10,000
216,000
120,000
190,000
600,000
Add up to $74,000, becomes the 1/1 R/E adjustment in the next year
(see next slide)
5 - 15
The Allocation EE
Cost Method
Year Subsequent to Acquisition
Beginning retained earnings
Depreciation expense
Amortization expense of goodwill
Equipment
Land
Goodwill
Difference between cost and book value
74,000
24,000
10,000
192,000
120,000
180,000
600,000
Add up to $108,000, becomes the 1/1 R/E adjustment in the next year
(see next slide)
5 - 16
The Allocation EE
Cost Method
2 Years Subsequent to Acquisition
Beginning retained earnings
Depreciation expense
Amortization expense of goodwill
Equipment
Land
Goodwill
Difference between cost and book value
108,000
24,000
10,000
168,000
120,000
170,000
600,000
5 - 17
The Allocation EE
Partial Equity Method
End of Year of Acquisition
Cost of goods sold
Depreciation expense
Amortization expense of goodwill
Equipment
Land
Goodwill
Difference between cost and book value
40,000
24,000
10,000
216,000
120,000
190,000
600,000
Add up to $74,000, becomes the 1/1 R/E adjustment in the next year
(see next slide)
5 - 18
The Allocation EE
Partial Equity Method
Year Subsequent to Acquisition
Beginning retained earnings
Depreciation expense
Amortization expense of goodwill
Equipment
Land
Goodwill
Difference between cost and book value
74,000
24,000
10,000
192,000
120,000
180,000
600,000
Add up to $108,000, becomes the 1/1 R/E adjustment in the next year
(see next slide)
5 - 19
The Allocation EE
Complete Equity Method
End of Year of Acquisition
Cost of goods sold
Depreciation expense
Amortization expense of goodwill
Equipment
Land
Goodwill
Difference between cost and book value
40,000
24,000
10,000
216,000
120,000
190,000
600,000
Add up to $74,000, becomes the 1/1 R/E adjustment in the next year
(see next slide)
5 - 20
The Allocation EE
Complete Equity Method
Year Subsequent to Acquisition
Investment in S
Depreciation expense
Amortization expense of goodwill
Equipment
Land
Goodwill
Difference between cost and book value
74,000
24,000
10,000
192,000
120,000
180,000
600,000
Add up to $108,000, becomes the 1/1 R/E adjustment in the next year
(see next slide)
Note: The investment account, instead of the beginning
R/E, is adjusted under the complete equity method
5 - 21
Push Down Accounting
Definition
A
subsidiary changes the accounting basis
in its separate financial statements based
on the purchase price paid by the parent
for its stock.
5 - 22
Push Down Accounting
S has outstanding
public debt?
No
Yes
Push down
accounting should
not be used
Yes
S has outstanding
senior class of capital stock?
No
<80%
Push down
accounting is
recommended
What is P’s % of ownership?
80-95%
<80%
Push down
accounting is
required
5 - 23
Advanced Accounting
by
Debra Jeter and Paul Chaney
Copyright © 2001 John Wiley & Sons, Inc. All rights reserved.
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5 - 24