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CHAPTER 4
SOLUTIONS TO EXERCISES AND PROBLEMS
EXERCISES
E4.1 Equity Method Accounting
Calculation of Equity in Net Income:
Williams reported net income $ 80,000,000
Revaluation writeoffs:
Plant assets $50,000,000/25 (2,000,000)
Goodwill impairment loss (25,000,000)
Equity in net income of Williams $ 53,000,000
Entries made by James during 2010:
Investment in Williams 450,000,000Capital stock 450,000,000
Investment in Williams 53,000,000
Equity in net income ofWilliams 53,000,000
Cash 24,000,000
Investment in Williams 24,000,000
E4.2 Equity Method Income and Working Paper Eliminations
(all amounts in millions)
a.Investment balance, 1/1/11 $2,286Investment balance, 1/1/10 = $2,000 + $200 2,200Change 862010 dividends 602010 equity income accrual 146Writeoff of plant asset revaluation = ($160/10) 16Sabers 2010 net income $ 162
b.Sabers stockholders equity, 1/1/10 $2,0002010 net income 1622010 dividends (60)Sabers stockholders equity, 1/1/11 $2,102
c.Sabers 2011 net income $ 130
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Extra depreciation on revalued plant assets (16)Equity income accrual $ 114
d. (C)
Equity income accrual 114
Dividends Saber 40Investment in Saber 74
(E)
Stockholders Equity Saber 2,102
Investment in Saber 2,102
(R)
Plant assets 160
Goodwill 40
Accumulated depreciation 16Investment in Saber 184
(O)
Depreciation expense 16
Accumulated depreciation 16
e. At the beginning of 2022, the plant assets are fully depreciated and the remaining balancefor goodwill is $40 - $30 = $10.
(R)
Plant assets 160Goodwill 10
Accumulated depreciation 160
Investment in S 10
Entry (O) is not needed since no revaluations are written off in 2022.
E4.3 Consolidation at End of First Year
a. The acquisition entry is as follows:
Investment in Saddlestone 10,300,000
Merger expenses 250,000
Capital stock 10,000,000
Contingent considerationliability 300,000
Cash 250,000
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Calculation of 2011 Equity in Net Income:
Saddlestones reported net income $ 3,000,000
Revaluation writeoff:
Identifiable intangibles $2,000,000/5 (400,000)
Equity in net income of Saddlestone $ 2,600,000
Peaks equity method entries for 2011:
Investment in Saddlestone 2,600,000
Equity in net income ofSaddlestone 2,600,000
Cash 1,000,000
Investment in Saddlestone 1,000,000
b. Calculation of goodwill is as follows:
Acquisition cost $ 10,300,000
Book value of Saddlestone (7,200,000)
Excess of acquisition cost over book value 3,100,000
Identifiable intangibles (2,000,000)
Goodwill $ 1,100,000
Consolidation working paper eliminating entries for 2011:
(C)
Equity in net income ofSaddlestone 2,600,000
Dividends Saddlestone 1,000,000
Investment in Saddlestone 1,600,000
(E)
Stockholders equitySaddlestone, 1/1 7,200,000
Investment in Saddlestone 7,200,000
(R)
Identifiable intangibles 2,000,000
Goodwill 1,100,000
Investment in Saddlestone 3,100,000
(O)
Amortization expense 400,000
Identifiable intangibles 400,000
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E4.4 Eliminating Entries after First and Second Years
a. Calculation of Equity in net income for 2012:
Safecos reported net income $ 1,600,000
Revaluation writeoffs:Equipment $500,000/5 (100,000)
Inventory 90% x $200,000 (180,000)
Goodwill impairment loss (50,000)
Equity in net income of Safeco $ 1,270,000
Peerlesss entries for 2012:
Investment in Safeco 8,000,000
Cash 8,000,000
Investment in Safeco 1,270,000Equity in net income ofSafeco 1,270,000
Cash 600,000
Investment in Safeco 600,000
Calculation of goodwill is as follows:
Acquisition cost $ 8,000,000
Book value of Safeco (7,000,000)
Excess of acquisition cost over book value 1,000,000Fair value less book value:
Equipment $ 500,000
Inventory 200,000 (700,000)
Goodwill $ 300,000
Consolidation working paper eliminating entries for 2012:
(C)
Equity in net income ofSafeco 1,270,000
Dividends Safeco 600,000
Investment in Safeco 670,000
(E)
Stockholders equitySafeco,1/1 7,000,000
Investment in Safeco 7,000,000
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(R)
Equipment, net 500,000
Inventory 200,000
Goodwill 300,000
Investment in Safeco 1,000,000
(O)
Depreciation expense 100,000
Cost of goods sold 180,000
Goodwill impairment loss 50,000
Equipment, net 100,000
Inventory 180,000
Goodwill 50,000
b. Calculation of Equity in Net Income for 2013:
Safecos reported net income $ 2,000,000
Revaluation writeoffs:
Equipment $500,000/5 (100,000)
Inventory 10% x $200,000 (20,000)
Equity in net income of Safeco $ 1,880,000
Peerlesss equity method entries for 2013:
Investment in Safeco 1,880,000
Equity in net income of Safeco 1,880,000
Cash 800,000
Investment in Safeco 800,000
The Investment in Safeco balance at December 31, 2013 is $8,000,000 + 1,270,000 600,000 +1,880,000 800,000 = $9,750,000.
Consolidation working paper eliminating entries for 2013:
(C)
Equity in net income of Safeco 1,880,000
Dividends Safeco 800,000
Investment in Safeco 1,080,000
(E)
Stockholders equitySafeco,1/1 8,000,000
Investment in Safeco 8,000,000
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Stockholders equitySafeco at 1/1/2013 = $7,000,000 + 1,600,000 600,000 = $8,000,000
(R)
Equipment, net 400,000
Inventory 20,000
Goodwill 250,000Investment in Safeco 670,000
(O)
Depreciation expense 100,000
Cost of goods sold 20,000
Equipment, net 100,000
Inventory 20,000
E4.5 Equity Method, Eliminating Entries, Several Years after Acquisition
a. Calculation of total goodwill is as follows:
Acquisition cost $ 5,000,000
Book value of Brussels (2,000,000)
Excess of acquisition cost over book value 3,000,000
Fair value less book value:
Land $ 450,000
Buildings (400,000)
Identifiable intangibles 1,000,000
Long-term debt 250,000 (1,300,000)
Goodwill $ 1,700,000
b. Calculation of Equity in net income for 2010:
Brussels reported net income $ 400,000
Revaluation writeoffs:
Buildings $(400,000)/20 20,000
Long-term debt $250,000/10 (25,000)
Goodwill impairment loss (50,000)
Equity in net income of Brussels $ 345,000
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c. Calculation of Investment in Brussels, 12/31/10
Investment in Brussels, 1/1/02 $ 5,000,000
Brussels reported income, 2002-2009 3,500,000
Brussels reported dividends, 2002-2009 (1,000,000)
Revaluation writeoffs, 2002-2009:Buildings $[(400,000)/20] x 8 160,000
Identifiable intangibles (full balance) (1,000,000)
Long-term debt $[250,000/10] x 8 (200,000)
Goodwill impairment loss (300,000)
Investment in Brussels, 1/1/10 6,160,000
Equity in net income, 2010 345,000
Brussels dividends, 2010 (90,000)
Investment in Brussels, 12/31/10 $ 6,415,000
d. Consolidation working paper eliminating entries for 2010:
(C)
Equity in net income of Brussels 345,000
Dividends Brussels 90,000
Investment in Brussels 255,000
(E)
Stockholders equityBrussels, 1/1 4,500,000
Investment in Brussels 4,500,000
Stockholders equity, January 1, 2010 = $2,000,000 + 3,500,000 1,000,000 = $4,500,000.
(R)Land 450,000
Long-term debt 50,000
Goodwill 1,400,000
Investment in Brussels 1,660,000
Buildings, net 240,000
Revaluations at January 1, 2010 = original revaluations less writeoffs for 2002-2009.
(O)
Interest expense 25,000
Buildings, net 20,000
Goodwill impairment loss 50,000
Long-term debt 25,000
Depreciation expense 20,000
Goodwill 50,000
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E4.6 Consolidation after Several Years
Calculation of total goodwill is as follows:
Acquisition cost $ 7,500,000
Book value of Baker (5,000,000)Excess of acquisition cost over book value 2,500,000
Fair value less book value:
Buildings (1,000,000)
Goodwill $ 1,500,000
Calculation of Equity in Net Income for 2011:
Bakers reported net income $ 300,000
Revaluation writeoffs:
Buildings $1,000,000/25 (40,000)
Goodwill impairment loss (100,000)Equity in net income of Baker $ 160,000
Calculation of Investment balance at December 31, 2011:
Investment in Baker, 12/31/04 $ 7,500,000
Baker reported income, 2005-2010 1,300,000
Baker reported dividends, 2005-2010 (400,000)
Revaluation writeoffs, 2005-2010:
Buildings ($1,000,000/25) x 6 (240,000)
Investment in Baker, 1/1/11 8,160,000
Equity in net income, 2011 160,000Dividends, 2011 (100,000)
Investment in Baker, 12/31/11 $ 8,220,000
Consolidation working paper eliminating entries for 2011:
(C)
Equity in net income of Baker 160,000
Dividends Baker 100,000
Investment in Baker 60,000
(E)
Stockholders equityBaker, 1/1 5,900,000
Investment in Baker 5,900,000
Stockholders equity, January 1, 2011 = $5,000,000 + 1,300,000 400,000 = $5,900,000.
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(R)
Buildings, net 760,000
Goodwill 1,500,000
Investment in Baker 2,260,000
Revaluations at January 1, 2011 = original revaluations less writeoffs for 2005-2010.
(O)
Depreciation expense 40,000
Goodwill impairment loss 100,000
Buildings, net 40,000
Goodwill 100,000
E4.7 Goodwill Impairment Losses
a.
Goodwill is not a standalone asset, but represents the value of above-average future performancepotential that cannot be assigned to identifiable assets such as property or specific intangibleassets. Because performance potential is related to business operations, to measure impairments inits value it must be connected with a specific business unit. In the case of Time Warner, asdiscussed in the text of Chapter 4, goodwill is assigned to Networks as a business unit. The WBNetwork is one part of this business unit, but does not comprise the entire unit.
b.Goodwill impairment testing is accomplished in two steps. First, the fair value of the business unitis compared with its book value. If book value exceeds fair value, we go on to the second step todetermine the amount of the impairment, if any. The second step compares the fair value of the
goodwill with its carrying value. An impairment loss is reported if its carrying value exceeds itsfair value.
Since The WB Network was shut down, its future performance potential will no longer benefitTime Warner, and the impairment charge is appropriate.
c.Time Warner has a 50% interest in The CW, so under U.S. GAAP it does not have a controllinginterest and reports its investment using the equity method. Time Warners equity in the netincome of The CW is reported as part of consolidated other income. The investment balance isreported as part of consolidated assets. The CWs individual assets, liabilities, revenues and
expenses are not reported on the consolidated financial statements.
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E4.8 Projecting Consolidation Entries
a.(R)
Land 80,000
Equipment, net 18,000Investment in Samson 98,000
Inventory has been sold, and the equipment revaluation as of the start of the third year is $30,000 (2 x 6,000) = $18,000.
(O)
Depreciation expense 6,000
Equipment, net 6,000
b.(R)
Land 80,000Investment in Samson 80,000
Inventory has been sold, and the equipment revaluation has been completely written off. Thereforeno eliminating entry (O) is appropriate.
c.No eliminating entries are necessary to recognize or write off the revaluations, because the assetsrequiring revaluation have been either sold or written off.
E4.9 Identifiable Intangibles and Goodwill, U.S. GAAP
Amortization expense for 2011:
Customer relationships $2,000,000/4 $ 500,000
Favorable leaseholds $6,000,000/5 1,200,000
Total $1,700,000
Impairment testing identifiable intangibles:
Customer relationshipsBook value = $2,000,000 2 x ($2,000,000/4) = $1,000,000
Book value > Sum of undiscounted cash flows? $1,000,000 > $800,000: YesImpairment loss = $1,000,000 - $650,000 = $350,000
Favorable leaseholdsBook value = $6,000,000 1.5 x ($6,000,000/5) = $4,200,000Book value > Sum of undiscounted cash flows? $4,200,000 < $4,500,000: No
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Brand namesBook value = $14,000,000Book value > Sum of undiscounted cash flows? $14,000,000 > $12,000,000: YesImpairment loss = $14,000,000 - $10,000,000 = $4,000,000
Impairment testing Goodwill:
Reporting Unit Unit FV < BV? Fair Value of GW GW impairment lossAsia $400,000,000 > $300,000,000:
No
South America $350,000,000> $200,000,000:No
Europe $500,000,000< $600,000,000:Yes
$500,000,000 325,000,000= 175,000,000
$250,000,000 175,000,000 =$75,000,000
Summary:Amortization expense identifiable intangibles $ 1,700,000
Impairment losses identifiable intangibles 4,350,000Goodwill impairment loss 75,000,000
Total $ 81,050,000
E4.10 Identifiable Intangibles and Goodwill, IFRS
Amortization expense for 2011:
Customer relationships $2,000,000/4 $ 500,000
Favorable leaseholds $6,000,000/5 1,200,000
Total $1,700,000
Impairment testing identifiable intangibles:
Customer relationshipsBook value = $2,000,000 2 x ($2,000,000/4) = $1,000,000Book value > Sum of discounted cash flows? $1,000,000 > $650,000: YesImpairment loss = $1,000,000 - $650,000 = $350,000
Favorable leaseholdsBook value = $6,000,000 1.5 x ($6,000,000/5) = $4,200,000Book value > Sum of discounted cash flows? $4,200,000 > $3,800,000: Yes
Impairment loss = $4,200,000 $3,800,000 = $400,000
Brand namesBook value = $14,000,000Book value > Sum of discounted cash flows? $14,000,000 > $10,000,000: YesImpairment loss = $14,000,000 - $10,000,000 = $4,000,000
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Impairment testing Goodwill:
Reporting Unit Unit FV < BV? GW impairment lossE. Asia $310,000,000 > $200,000,000: No
Indonesia $90,000,000 < $100,000,000: Yes $100,000,000 90,000,000 =$10,000,000
Brazil $125,000,000 < $130,000,000: Yes $130,000,000 125,000,000 =$5,000,000
Mediterranean $180,000,000 < $220,000,000: Yes $220,000,000 180,000,000 =$40,000,000
Scandinavia $190,000,000 < $300,000,000: Yes $300,000,000 190,000,000 =$110,000,000; impairment limited tofull goodwill balance of $100,000,000.
Summary:Amortization expense identifiable intangibles $ 1,700,000Impairment losses identifiable intangibles 4,750,000Goodwill impairment loss 155,000,000
Total $161,450,000
E4.11 Consolidated Income Statement
a.(amounts in millions)
Sales $5,000 + 2,000 $7,000
Cost of goods sold $3,000 + 800 + 160 3,960
Gross margin 3,040
Depreciation expense $500 + 140 (200/10) 620
Interest expense $100 + 60 + (100/5) 180
Other expenses $600 + 700 1,300
Total operating expenses 2,100
Net income $ 940
b.Parson reports its own income of $800 million plus its equity in the income of Soaper of $140million. Equity in the income of Soaper is Soapers reported income adjusted for write-offs ofSoapers net asset revaluations. Consolidated income is Parsons and Soapers reported revenuesand expenses, with Soapers expenses adjusted for the revaluation writeoffs. Parsons separatelyreported income and consolidated income therefore report the same items, packaged differently.
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E4.12 Amortization and Impairment Testing of Identifiable Intangible Assets
a.
Technology
Arroyo $15,000/5 x 9/12 = $ 2,250WebEx $312,000/4 x 1/12 = 6,500
Customer Relationships
Arroyo $14,000/7 x 9/12 = 1,500
WebEx $153,000/6 x 1/12 = 2,125
Total amortization expense $ 12,375
b.
Technology
7/31/07Bookvalue
Book value>Undiscountedcash flows? Impairment loss
Arroyo $ 12,750 $12,750>$14,000? No -- --
WebEx 305,500 $305,500>$300,000? Yes $305,500-250,000= $ 55,500
Customer
Relationships
Arroyo 12,500 $12,500>$16,000? No -- --
WebEx 150,875 $150,875>$140,000? Yes $150,875-100,000= 50,875
Total impairment loss $106,375
c.
Technology
Customer
Relationships
Arroyo $ 12,750 $ 12,500
WebEx 250,000 100,000
7/31/07 book value $ 262,750 $ 112,500
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PROBLEMS
P4.1 Condensed Consolidated Financial Statements One Year after Acquisition
a. Calculation of Equity in net income for 2010:
Santos reported net income $ 5,000,000
Revaluation writeoffs:
Inventory (1) (2,000,000)
Plant assets $8,000,000/8 (1,000,000)
Patents $1,500,000/4 (375,000)
Long-term debt $1,000,000/10 100,000
Goodwill impairment loss (400,000)
Equity in net income of Santo $ 1,325,000
(1) Santos beginning inventory on its own books is $3,000,000 (= $5,200,000 + 4,000,000
6,200,000). Since Santos cost of goods sold is $4,000,000, its beginning inventory iscompletely sold in 2010, and the revaluation is written off.
b.
Consolidation Working Paper, December 31, 2010Trial Balances Taken From
Books
Dr (Cr)
Eliminations
Ponon Santo Dr Cr
Consolidated
Balances
Cash and receivables $ 4,500,000 $ 3,100,000 $ 7,600,000
Inventory 5,000,000 5,200,000 (R) 2,000,000 2,000,000 (O-1) 10,200,000Plant assets, net 8,000,000 12,000,000 (R) 8,000,000 1,000,000 (O-2) 27,000,000
Investment in Santo 26,325,000 -- 1,325,000 (C)10,000,000 (E)15,000,000 (R)
--
Patents -- -- (R) 1,500,000 375,000 (O-3) 1,125,000
Goodwill -- -- (R) 4,500,000 400,000 (O-5) 4,100,000
Current liabilities (5,100,000) (2,000,000) (7,100,000)
Long-term debt (20,000,000) (3,300,000) (O-4) 100,000 1,000,000 (R) (24,200,000)
Capital stock (8,000,000) (6,000,000) (E) 6,000,000 (8,000,000)
Retained earnings, Jan. 1 (4,800,000) (4,000,000) (E) 4,000,000 (4,800,000)
Sales (30,000,000) (13,200,000) (43,200,000)
Equity in income of Santos (1,325,000) -- (C) 1,325,000 --Cost of goods sold 18,000,000 4,000,000 (O-1) 2,000,000 24,000,000
Depreciation andamortization expense
2,000,000 3,200,000 (O-2) 1,000,000(O-3) 375,000 6,575,000
Interest and other expenses 5,400,000 1,000,000 100,000 (O-4) 6,300,000
GW impairment loss -- -- (O-5) 400,000 _______ 400,000
$ -0- $ -0- $ 31,200,000 $31,200,000 $ -0-
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c.
Consolidated Statement of Income and Retained Earnings For the Year 2010
Sales $ 43,200,000
Costs of goods sold (24,000,000)
Gross margin 19,200,000
Operating expenses:Depreciation and amortization expense $ 6,575,000
Interest and other expenses 6,300,000
Goodwill impairment loss 400,000 (13,275,000)
Net income 5,925,000
Retained earnings, beginning balance 4,800,000
Retained earnings, ending balance $ 10,725,000
Consolidated Balance Sheet, December 31, 2010
Assets
Cash and receivables $ 7,600,000
Inventory 10,200,000Plant assets, net 27,000,000
Patents 1,125,000
Goodwill 4,100,000
Total assets $ 50,025,000
Liabilities and stockholders equity
Current liabilities $ 7,100,000
Long-term debt 24,200,000
Capital stock 8,000,000
Retained earnings 10,725,000
Total liabilities and stockholders equity $ 50,025,000
P4.2 Equity Method and Eliminating Entries Three Years after Acquisition
a. Calculation of Equity in Net Income for 2012:
Sea Coasts reported net income for 2012 $ 130,000
Revaluation writeoffs:
Plant assets ($100,000)/10 10,000
Identifiable intangibles $300,000/20 (15,000)
Equity in net income of Sea Coast $ 125,000
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b. Calculation of Investment balance at December 31, 2012:
Investment in Sea Coast, December 31, 2009 $ 2,000,000
Sea Coasts reported income, 2010-2012 400,000
Sea Coasts reported dividends, 2010-2012 (60% of reported
income) (240,000)Revaluation writeoffs, 2010-2012:
Plant assets [($100,000)/10] x 3 30,000
Identifiable intangibles ($300,000/20) x 3 (45,000)
Investment in Sea Coast, December 31, 2012 $ 2,145,000
Note to instructor: Under LIFO and increasing inventory, the acquisition daterevalued inventory is assumed to still be on hand.
c. Consolidation working paper eliminating entries for 2012:
(C)Equity in net income of Sea Coast 125,000
Dividends Sea Coast(.6 x $130,000) 78,000
Investment in SeaCoast 47,000
(E)
Stockholders equitySea Coast,1/1 1,508,000
Investment in Sea Coast
1,508,000Sea Coasts stockholders equity, December 31, 2009 = $1,400,000 (acquisition cost $2,000,000less excess over book value $600,000).
Sea Coasts stockholders equity, January 1, 2012 = $1,400,000 + (1 - .6)(400,000 130,000) =$1,508,000.
(R)
Inventory 400,000
Identifiable intangibles 270,000
Plant assets, net 80,000
Investment in SeaCoast 590,000
Revaluations at January 1, 2012 = original revaluations less writeoffs for 2010 and 2011.
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(O)
Plant assets, net 10,000
Amortization expense 15,000
Depreciation expense 10,000
Identifiable intangibles 15,000
d.Pelicans income from its own operations plus equity in net income of Sea Coast = consolidated
net income: $500,000 + $125,000 = $625,000.
P4.3 Consolidation at End of First Year, Preacquisition Contingency
a. Calculation of Equity in Net Income for 2011:
Sanders reported net income for 2011 $ 500,000
Revaluation writeoffs:
Inventory $80,000 x 60% (48,000)Equipment $200,000/10 (20,000)
Equity in net income of Sanders $ 432,000
Perkinsentries for 2011:
Investment in Sanders 4,000,000
Merger expenses 50,000
Restructuring expenses 100,000
Cash 4,150,000
Investment in Sanders 432,000
Equity in net income ofSanders 432,000
Cash 150,000
Investment in Sanders 150,000
b. Consolidation working paper eliminating entries for 2011:
(C)
Equity in net income ofSanders 432,000
Dividends Sanders 150,000Investment in Sanders 282,000
(E)
Stockholders equitySanders, 1/1 2,200,000
Investment in Sanders 2,200,000
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(R)
Inventory 80,000
Equipment, net 200,000
In-process research anddevelopment 300,000
Goodwill 1,305,000Lawsuit liability 85,000
Investment in Sanders 1,800,000
Note: Because the change in the lawsuit liability occurs within the measurement period, theincreased liability value increases acquisition date goodwill.
(O)
Cost of goods sold 48,000
Depreciation expense 20,000
Inventory 48,000
Equipment, net 20,000
P4.4 Consolidated Balance Sheet Working Paper, Bargain Purchase (see related P3.4)
(all amounts in millions)
a. Calculation of Equity in Net Income for 2013:
Saxons reported net income for 2013 ($10,000 + 10 8,000 40 25 1,600) $ 345
Revaluation writeoffs:
Inventory (100)Marketable securities 50
Buildings and equipment $300/20 (15)
Long-term debt $110/5 (22)
Equity in net income of Saxon $ 258
Calculation of Investment balance, December 31, 2013:
Investment balance, December 31, 2012 (1) $2,000
Equity in net income for 2013 258
Dividends for 2013 (100)
Investment balance, December 31, 2013 $2,158
(1) Paxon acquired Saxon for $1,800, but there is a bargain gain that increases the investmentbalance by $200, as follows:
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Calculation of gain on acquisition:
Acquisition cost $ 1,800
Book value ($100 + 350 + 845) (1,295)
Excess of acquisition cost over book value 505
Excess of fair value over book value:
Inventory $ 100Marketable securities (50)
Land 245
Buildings and equipment 300
Long-term debt (discount) 110 705
Gain on acquisition $ 200
Therefore Paxons entry to record the acquisition was:
Investment in Saxon 2,000
Cash 1,800
Gain on acquisition 200
b.
Consolidation Working Paper, December 31, 2013Trial Balances Taken
From Books
Dr (Cr)
Eliminations
Paxon Saxon Dr Cr
Consolidated
Balances
Cash and receivables $ 3,100 $ 800 $ 3,900
Inventory 2,260 940 (R) 100 100 (O-1) 3,200
Marketable securities -- -- (O-2) 50 50 (R) --Investment in Saxon 2,158 -- 158 (C)
1,295 (E)705 (R)
--
Land 650 300 (R) 245 1,195
Buildings and equipment, net 3,600 1,150 (R) 300 15 (O-3) 5,035
Current liabilities (2,020) (1,200) (3,220)
Long-term debt (5,000) (450) (R) 110 22 (O-4) (5,362)
Common stock (500) (100) (E) 100 (500)
Additional paid-in capital (1,200) (350) (E) 350 (1,200)
Retained earnings, Jan. 1 (2,610) (845) (E) 845 (2,610)
Dividends 500 100 100 (C) 500
Sales revenue (30,000) (10,000) (40,000)Equity in income of Saxon (258) -- (C) 258 --
Gain on sale of securities -- (10) 50 (O-2) (60)
Cost of goods sold 26,000 8,000 (O-1) 100 34,100
Depreciation expense 300 40 (O-3) 15 355
Interest expense 250 25 (O-4) 22 297
Other operating expenses 2,770 1,600 ______ _______ 4,370
$ -0- $ -0- $ 2,495 $ 2,495 $ -0-
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c.
Consolidated Statement of Income and Retained Earnings For the Year 2013
Sales $ 40,000
Costs of goods sold (34,100)
Gross margin 5,900Operating expenses:
Depreciation expense $ 355
Interest expense 297
Other operating expenses 4,370 (5,022)
Income before other gains 878
Gain on sale of securities 60
Net income 938
Retained earnings, January 1 2,610
Dividends (500)
Retained earnings, December 31 $ 3,048
Consolidated Balance Sheet, December 31, 2013
Assets
Cash and receivables $ 3,900
Inventory 3,200
Land 1,195
Buildings and equipment, net 5,035
Total assets $ 13,330
Liabilities and stockholders equity
Current liabilities $ 3,220
Long-term debt 5,362
Common stock 500
Additional paid-in capital 1,200
Retained earnings 3,048
Total liabilities and stockholders equity $ 13,330
P4.5 Goodwill Allocation and Impairment
a.
Identifiable assets acquired $ 53,000,000
Liabilities assumed (19,000,000)Net identifiable assets acquired 34,000,000
Total acquisition cost 50,000,000
Total goodwill $ 16,000,000
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Allocation to business units:
Unit X Unit Y Unit Z Total
Identifiable assets acquired $ 30,000,000 $16,000,000 $ 7,000,000 $ 53,000,000
Liabilities assumed (12,000,000) (5,000,000) (2,000,000) (19,000,000)
Net assets assigned $ 18,000,000 $11,000,000 $ 5,000,000 $ 34,000,000
Unit X Unit Y Unit Z Unit J
Fair value of reporting unit $ 24,000,000 $ 15,000,000 $ 10,000,000
Less: Net assets assigned (18,000,000) (11,000,000) (5,000,000)
Increase in fair value __ N/A___ ___N/A___ ___N/A___ $ 5,000,000
Tentative allocation ofgoodwill 6,000,000 4,000,000 5,000,000 5,000,000
Total tentative allocation is$20,000,000; goodwill to beassigned is $16,000,000.
20% reduction (1,200,000) (800,000) (1,000,000) (1,000,000)Allocation of goodwill $ 4,800,000 $ 3,200,000 $ 4,000,000 $ 4,000,000
b. Step 1 of impairment test: Compare the fair value of each reporting unit at December 31,2010 with its book value at that date.
Unit X Unit Y Unit Z Unit J
Fair value atDecember 31, 2010 $26,000,000 $ 12,000,000 $ 5,000,000 $ 63,000,000
Carrying amount atDecember 31, 2010 25,000,000 13,000,000 7,000,000 65,000,000
Difference $ 1,000,000 $(1,000,000) $(2,000,000) $(2,000,000)
Preliminary conclusion Not impaired May beimpaired
May beimpaired
May beimpaired
Step 2 of the impairment test: For those reporting units where goodwill may be impaired, calculatethe implied fair value of goodwill at December 31, 2010 and compare to the carrying amount ofgoodwill at that date.
Unit Y Unit Z Unit J
Fair value of reporting unit $ 12,000,000 $ 5,000,000 $63,000,000
Fair value of identifiable net assetsat December 31, 2010 7,000,000 4,000,000 58,000,000
Implied value of goodwill 5,000,000 1,000,000 5,000,000
Carrying amount of goodwill 3,200,000 4,000,000 4,000,000
Difference $ 1,800,000 $(3,000,000) $ 1,000,000
Conclusion Goodwill is notimpaired
Goodwill isimpaired
Goodwill is notimpaired
Goodwill is impaired for Reporting Unit Z. A $3,000,000 goodwill impairment loss should berecorded at December 31, 2010.
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P4.6 Intangible Assets and Goodwill: Amortization and Impairment
2013 amortization expense:
Customer lists $500,000/5 $ 100,000
Developed technology $800,000/10 80,000Total $ 180,000
2013 impairment test for identifiable intangibles:
Customerlists
Developedtechnology
Internetdomain name
Original carrying amount $ 500,000 $ 800,000 $ 1,300,000
Less: amortization
2011 (100,000) (80,000)
2012 (100,000) (80,000)
2013 (100,000) (80,000) ________ Carrying amount, December 31, 2013 $ 200,000 $ 560,000 $ 1,300,000
Step 1 of impairment test: To determine whether impairment has occurred, compare theundiscounted future cash flows from the asset to its carrying value.
Customerlists
Developedtechnology
Internetdomain name
Future undiscounted cash flows $ 250,000 $ 500,000 $ 1,000,000
Carrying amount 200,000 560,000 1,300,000
Difference $ 50,000 $ (60,000) $ (300,000)
Conclusion Not impaired Impaired Impaired
Step 2 of impairment test: For intangibles that are deemed impaired in Step 1, calculate amount ofimpairment as the difference between discounted cash flows and carrying value.
Developedtechnology
Internetdomain name
Future discounted cash flows $ 420,000 $ 750,000
Carrying amount 560,000 1,300,000
Impairment $ 140,000 $ 550,000
2013 goodwill impairment test:
Step 1 of impairment test: compare fair value of reporting unit at December 31, 2013 to thecarrying amount of the unit at that date.
Fair value of reporting unit $17,000,000
Carrying amount 18,500,000
Difference $(1,500,000)
Conclusion: Goodwill may be impaired.
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Step 2 of impairment test: Calculate the implied fair value of goodwill at December 31, 2013 andcompare to the carrying amount at that date.
Fair value of reporting unit $ 17,000,000
Fair value of identifiable net assets 14,200,000
Implied fair value of goodwill 2,800,000Carrying amount of goodwill 6,200,000
Difference $ (3,400,000)
Conclusion: Goodwill impairment loss is $3,400,000.
Summary:
Amortization expense for 2013:
Customer lists $ 100,000
Developed technology 80,000 $ 180,000
Impairment write-offs for 2013:
Developed technology $ 140,000Internet domain name 550,000
Goodwill 3,400,000 4,090,000
Total expense for 2013 $ 4,270,000
P4.7 Consolidated Balance Sheet Working Paper, Three Years after Acquisition (see
related P3.2)
(all amounts in millions)
a. Calculation of Equity in Net Income for fiscal 2011, 2012, and 2013:
2011 2012 2013
Saxons reported net income (loss) $ 15 $ (2) $ 12 (1)
Revaluation writeoffs:
Property, plant and equipment $(60)/20 3 3 3
Patents and trademarks $10/5 (2) (2) (2)
Long-term debt $(3)/3 1 1 1
Advanced technology $5/5 (1) (1) (1)
Customer lists impairment loss (2) (4)
Goodwill impairment loss _(2) _(3) _(2)
Equity in net income of Saxon $ 14 $ (6) $ 7
(1) $12 = $900 800 88
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Calculation of Investment balance, June 30, 2013:
Investment balance, June 30, 2010 (adjusted to remove earnings contingency) $ 110
Equity in net income for fiscal 2011 14
Equity in net income for fiscal 2012 (6)
Equity in net income for fiscal 2013 7
Increase in GOCs AOCI for fiscal 2011-2013 (= $5 3) __2Investment balance, June 30, 2013 $ 127
b.
Consolidation Working Paper, June 30, 2013Trial Balances
Taken From Books
Dr. (Cr.)
Eliminations
ITI GOC Dr Cr
Consolidated
Balances
Current assets $ 232 $ 12 (R) 5 $ 249
Property, plant andequipment, net 600 140 (O-1) 3 54 (R) 689
Identifiable intangible assets 1,100 30 (R) 6(R) 3(R) 23
2 (O-2)1 (O-4)4 (O-5)
1,155
Investment in GOC 127 -- 7 (C)55 (E)65 (R)
--
Goodwill (1) -- -- (R) 83 2 (O-6) 81
Current liabilities (175) (10) (185)
Long-term liabilities (1,125) (105) (O-3) 1 1 (R) (1,230)
Common stock (22) (4) (E) 4 (22)
Additional paid-in capital (580) (60) (E) 60 (580)Retained earnings, July 1 (118) 12 12 (E) (118)
Accumulated othercomprehensive income (20) (5) (E) 5 (20)
Treasury stock 8 2 2 (E) 8
Sales revenue (2,000) (900) (2,900)
Equity in income of Saxon (7) -- (C) 7 --
Cost of goods sold 1,400 800 2,200
Goodwill impairment loss -- -- (O-6) 2 2
Other operating expenses 580
_____
88
_____
(O-2) 2(O-4) 1(O-5) 4
3 (O-1)1 (O-3)
_______
____671
$ -0- $ -0- $ 209 $ 209 $ -0-
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(1) Acquisition-date goodwill is calculated as follows:
Acquisition cost (adjusted) $ 110
GOCs book value (40)
Excess of acquisition cost over book value 70
Excess of fair value over book value:
Inventory $ 5Property, plant and equipment (60)
Patents and trademarks 10
Advanced technology 5
Customer lists 25
Long-term debt (3) _(18)
Goodwill $ 88
c.
Consolidated Statement of Income and Retained Earnings For Fiscal 2013
Sales revenue $ 2,900
Costs of goods sold (2,200)Gross margin 700
Operating expenses:
Goodwill impairment loss $ 2
Other operating expenses _671 __673
Net income 27
Retained earnings, beginning balance __118
Retained earnings, ending balance $ 145
Consolidated Balance Sheet, June 30, 2013
Assets
Current assets $ 249
Property, plant and equipment, net 689
Identifiable intangible assets 1,155
Goodwill __81
Total assets $ 2,174
Liabilities and stockholders equity
Current liabilities $ 185
Long-term liabilities 1,230
Common stock 22
Additional paid-in capital 580
Retained earnings 145Accumulated other comprehensive income 20
Treasury stock __(8)
Total liabilities and stockholders equity $ 2,174
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P4.8 Working Paper Eliminating Entries, Partial Year Consolidation (see related P3.3)
(all numbers in millions)
a. Calculation of Equity in net income for 2003:
Pharmacias reported net income $ 5,000Revaluation writeoffs:
Inventory (2,939)
Property, plant and equipment [$(317)/20] x [8.5/12] 11
In-process research and development (716)
Developed technology rights $31,596/11 x (8.5/12) (2,035)
Long-term debt 12
Other assets $(15,606)/10 x (8.5/12) 1,105
Equity in net income of Pharmacia $ 438
b. Consolidation working paper eliminating entries for 2003:
(C)
Equity in net income of Pharmacia 438
Investment in Pharmacia 438
(E)
Stockholders equityPharmacia,4/16/03 7,236
Investment in Pharmacia 7,236
(R)
Inventory 2,939Long-term investments 40
In-process R&D 5,052
Developed technology rights 37,066
Goodwill 21,304
Property, plant andequipment 317
Long-term debt 1,841
Other assets 15,606
Investment in Pharmacia 48,637
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b.
Exploration and Production
CGU Value in use Carrying value Impairment loss
UK $ 9,000 $ 1,114 NoneUS 35,000 6,144 None
Rest of world 2,500 2,840 $ 340
Total $ 46,500 $ 10,098
Refining and Marketing
CGU Value in use Carrying value Impairment loss
Refining $ 13,000 $ 1,557 None
Retail 6,000 1,938 None
Lubricants and other 4,000 4,880 $ 880
Total $ 23,000 $ 8,375
Total goodwill impairment loss is $340 + 880 = $1,220
c.
$2,840 2,140 = $700, suggesting a GW impairment loss of that amount. However, total goodwillallocated to the Rest of World CGU is $515. Therefore, the goodwill impairment loss is $515, andother assets of the CGU would be written down, based on appropriate impairment tests.
d.
U.S. GAAP requires goodwill to be assigned to reporting units, in this case Exploration andProduction, and Refining and Marketing. Goodwill is then evaluated using a two-step test.Goodwill is tested for impairment only if the fair value of the reporting unit is less than its carryingvalue. Because fair value is generally calculated using discounted cash flows, we assume it can beapproximated by value in use. For both reporting units above, value in use significantly exceedscarrying value, so no impairment loss is reported.
Because reporting units aggregate CGUs, it is likely that CGUs with carrying value greater thanvalue in use will be offset by those with a value in use that is greater than carrying value whenapplying the first step for impairment testing under U.S. GAAP.
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P4.10 Consolidation One and Two Years after Acquisition
a.
The investment cost underSFAS 141R amounts to $598,000,000 [= ($590,000,000 $15,000,000)
+ $23,000,000], and the $248,000,000 excess of acquisition cost over book value ($598,000,000 $350,000,000) is allocated as follows, with goodwill being the residual at the bottom:
Excess of acquisition cost over book value $ 248,000,000
Allocation to identifiable items:
Inventories (30,000,000)
Identifiable intangibles (5-year life) (40,000,000)
In-process research and development (IPRD) (60,000,000)
Plant assets (20-year life, straight-line) (50,000,000)
Goodwill (unallocated balance) $ 68,000,000
b. 2007 equity income accrual:
Essexs reported net income $ 140,000,000
Revaluation write-offs:
FIFO inventory sold (.4 X $30,000,000) (12,000,000)
Amortization of identifiable intangibles ($40,000,000/5) (8,000,000)
Depreciation of plant assets ($50,000,000/20) (2,500,000)
Goodwill impairment (15,000,000)
Equity income accrual $ 102,500,000
December 31, 2007 working paper eliminations:
(C)
Equity income accrual 102,500,000
Dividends S (.55 x$140,000,000) 77,000,000
Investment in S 25,500,000
(E)
Stockholders equity Essex,1/25/07
350,000,000
Investment in S 350,000,000
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(R)
Inventories 30,000,000
Identifiable intangibles 40,000,000
In-process research anddevelopment 60,000,000
Plant assets 50,000,000Goodwill 68,000,000
Investment in S 248,000,000
(O)
Cost of goods sold 12,000,000
Amortization expense 8,000,000
Depreciation expense 2,500,000
Goodwill impairment loss 15,000,000
Inventories 12,000,000
Identifiable intangibles 8,000,000
Accumulated depreciation2,500,000
Goodwill 15,000,000
c. 2008 equity income accrual:
Essexs reported net income $160,000,000
Revaluation write-offs:
Amortization of identifiable intangibles ($40,000,000/5) (8,000,000)
Depreciation of plant assets ($50,000,000/20) (2,500,000)
IPRD impairment (20,000,000)
Equity income accrual $129,500,000
December 31, 2008, working paper eliminations:(C)
Equity income accrual 129,500,000
Dividends S (.55 x$160,000,000) 88,000,000
Investment in S 41,500,000
(E)
Stockholders equity Essex,1/1/08 (1) 413,000,000
Investment in S 413,000,000
(1) $350,000,000 + $140,000,000 - $77,000,000
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(R)
Inventories (.6 x $30,000,000)18,000,000
Identifiable intangibles 32,000,000
In-process research and
development 60,000,000Plant assets 50,000,000
Goodwill 53,000,000
Accum. depreciation 2,500,000
Investment in S 210,500,000
(O)
Amortization expense 8,000,000
Depreciation expense 2,500,000
IPRD impairment loss 20,000,000
Identifiable intangibles 8,000,000
Accumulated depreciation2,500,000
IPRD 20,000,000
P4.11 Intangibles under IFRS
a.
Whereas the double-declining balance rate is twice the straight-line rate, 150% declining balance is1.5 x 10% straight-line rate, or 15%. Following the conventional declining-balance calculations,
we have this amount of amortization expense for 2011, the second year after acquisition:
Amortization expense = .15 x [50,000,000 (.15 x 50,000,000)] = 6,375,000
b.
At December 31, 2010, the carrying amount is 9,000,000 after 2010 amortization of 1,000,000,and the market value of these intangibles is 9,500,000.
December 31, 2010 entries are:
Amortization expense 1,000,000Intangible assets 1,000,000
Intangible assets 500,000
Revaluation surplus(OCI) 500,000
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December 31, 2011, entries are:
Amortization expense 1,055,555
Intangible assets 1,055,555
9,500,000/9 = 1,055,555
Revaluation surplus (OCI) 500,000
Loss 944,445
Intangible assets 1,444,445
At this point the ending carrying amount is 7,000,000 (= 10,000,000 1,000,000 + 500,000 1,055,555 1,444,445], equal to the market value on that date.
c.
IFRS impairment loss = carrying amount greater of (value in use, 15,300,000; market value,
14,000,000) = 17,000,000 15,300,000 = 1,700,000.
U.S. GAAP impairment loss = 0 (sum of undiscounted cash flows 18,000,000 > carrying amount,17,000,000, indicating no impairment).
The two-step test in U.S GAAP removes some potential impairments from consideration. IFRSgoes immediately to an amount lower than the sum of the undiscounted cash flows, and will likelyrecognize more impairment losses over time than U.S. GAAP.
P4.12 Consolidation in First Year, Intangible Asset Issues
(all dollar amounts in millions)
a.
Net Assets = Assets - Liabilities$26,900 = $(20,800 + 9,400 + 4,800) LiabilitiesLiabilities = $35,000 $26,900Liabilities = $8,100
b.
Going by the book, the question is simply whether useful lives can be reasonably estimated orwhether the intangible has an obviously very long indeterminate (indefinite) life. Many cases willbe clear-cut and can be justified to the auditors but others will be in gray areas such that the desiredreporting result will call forth the case justifying the classification of the intangible one way oranother.
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In these gray areas, management may elect to minimize periodic amortization charges againstearnings and take their chances on the somewhat random and very subjective impairment tests. Tothe extent possible, management would likely classify items and load cost in the indefinite-livedcategory to minimize the effect on earnings.
c.
With goodwill no longer being subject to amortization, and impairment charges being part ofincome from continuing operations, companies may seek to lower the probability that they willhave to recognize goodwill impairment charges. The subjectivity inherent in valuing the reportingunits to which the goodwill is assignedcash flow forecasts and discount rate selectionsfacilitates decisions to load goodwill onto reporting units that are less-likely impairmentcandidates, i.e., units with fair value significantly above carrying value.
d.
Revaluation of limited-life intangibles is $2,000 (= $3,000 $1,000).Amortization of this revaluation for 2007 = $2,000/15 x 9/12 = $100.Equity method income = $1,000 $100 = $900
Consolidation Working Paper Entries:
(C)
Equity income 900
DividendsCaremark 550
Investment in Caremark 350
(E)Stockholders equityCaremark (1) 1,700
Investment in Caremark 1,700
(1) $26,900 $20,800 ($9,400 $5,000)
(R)
Goodwill 20,800
Identifiable intangibles, limited life 2,000
Identifiable intangibles, indefinite life(2) 2,400
Investment in Caremark 25,200
(2) $6,400 $4,000
(O)
Amortization expense 100
Identifiable intangibles,limited life 100
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