CH 5

9/13/2001 02:48:00 PM
5 ALLOCATION AND DEPRECIATION OF DIFFERENCES BETWEEN COST

AND BOOK VALUE
Learning Objectives:
1. Calculate and allocate the difference between cost and book value to the subsidiarys
assets and liabilities.
2. E!lain how any ecess of fair value over ac"uisition cost of net assets is allocated to
reduce the subsidiarys assets and liabilities in the case of bargain !urchases.
#. E!lain how goodwill is $easured at the ti$e of the ac"uisition.
%. &escribe how the allocation !rocess differs if less than 1''( of the subsidiary is
ac"uired.
). *ecord the entries needed on the !arents books to account for the invest$ent under
the three $ethods: the cost+ the !artial e"uity+ and the co$!lete e"uity $ethods.
,. -re!are work!a!ers for the year of ac"uisition and the year.s/ subse"uent to the
ac"uisition+ assu$ing that the !arent accounts for the invest$ent using the cost+ the !artial
e"uity+ and the co$!lete e"uity $ethods.
0. 1nderstand the allocation of the difference between cost and book value to long2ter$
debt co$!onents.
3. E!lain how to allocate the difference between cost and book value when so$e assets
have fair values below book values.
4. &istinguish between recording the subsidiary de!reciable assets at net versus gross fair
values.
1'. 1nderstand the conce!t of !ush down accounting.
1
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C56-7E* )
In the News:
7echnology billionaire -aul 6llen+ in his latest $ove to asse$ble a cable e$!ire+ agreed to
!ay 82.) billion in cash for Charter Co$$unications 9nc. and assu$e 82 billion of the
cable syste$s debt. 7he record !rice further escalates the !re$iu$s co$$unications
co$!anies are willing to !ay to gather u! !ieces of the cable industry.
1
:hen a co$!any !ays a large !re$iu$ to consu$$ate an ac"uisition+ the
allocation of that !re$iu$ to the accounts in the balance sheet beco$es a crucial issue
under !urchase accounting rules. 6s they $ature+ the balance sheet accounts will i$!act
the inco$e state$ent via de!reciation+ cost of goods sold+ etc.+ affecting the !atterns and
trend in re!orted earnings for years to co$e. 7hese effects on earnings !rovide incentives
for fir$s to use creative $eans to avoid de!ressing future earnings. One such $ethod is
to charge large a$ounts to in2!rocess research and develo!$ent e!ense.
FASBs recently issued opinion fundamentally changed the accounting for
goodwill amortization. As a result of the recent recommendations from FASB,
goodwill is no longer amortized over a finite life. Instead, goodwill is carried on the
balance sheet, and the account is not adusted, unless an impairment e!ists.
6s a result+ co$!anies who !reviously clai$ed that !urchase accounting ;drains<
future earnings via the a$orti=ation of goodwill will no longer be able to cite this as a
criticis$ of !urchase accounting. 9nstead of being e!ensed through the inco$e state$ent
via the a$orti=ation !rocess+ goodwill re$ains on the balance sheet at the value
deter$ined as of the ac"uisition date+ ece!t when i$!air$ent is dee$ed to have
occurred.
In the News:
7he >ecurities and Echange Co$$ission is cracking down on the !o!ular write2offs for
;in2!rocess research and develo!$ent.< *egulators+ which believe this trendy accounting
is being i$!ro!erly used to $ani!ulate earnings+ are trying to stay on to! of an ac"uisition
boo$ in which sheer s!eculation about a co$!any can affect the buyers botto$ line?
7argeted co$!anies are recoiling at the >EC initiative because it has forced earnings
restate$ents. @or ea$!le+ when Envoy Cor!. disclosed that the >EC was reviewing its
accounting for three ac"uisitions+ Envoys stock !rice that day fell to 82,.)' fro$ 8#,.
7hree $onths later Envoy announced that it had lowered its !revious *A& write2offs to
81%., $illion fro$ 8,3 $illion+ resulting in restate$ents for three years. 7he following
$onth the co$!any agreed to be !urchased by Buintiles 7ransnational Cor!. in a stock
swa! valued at about 81.% billion.
2
9n the !receding cha!ter+ it was assu$ed that any difference between ac"uisition
cost and the book value of the e"uity interest ac"uired was entirely attributable to the
under2 or overvaluation of land+ a nona$orti=able asset+ on the books of the subsidiary.
7his cha!ter focuses on a $ore co$!le and realistic allocation of the difference to
1
WSJ, 7/31/98, p. A3, Allen to Pay Record Su !or "a#le $%r,& #y '#en S(ap%ro.
2
WSJ, 2/1/99, p. )4, *%+(,-ec( $%r. /p.et 01er S'" "rac2do3n,& #y M%c(ael
Sc(roeder.
2
9/13/2001 02:48:00 PM
various assets and liabilities in the consolidated balance sheet and the de!reciation of the
difference in the consolidated inco$e state$ent. 9n the following !ages+ we first !rovide
ea$!les of the allocation of the difference between cost and book value on the
acquisition ate. :e net etend the ea$!les to deal with the su!sequent effects on
the consolidated financial state$ents under the various $ethods of accounting for
invest$ents that we reviewed in Cha!ter %.
ALLOCATION OF DIFFERENCE BETWEEN COST AND BOOK VALUE TO
ASSETS AND LIABILITIES OF SUBSIDIAR"# Acquisition Date
:hen consolidated financial state$ents are !re!ared+ asset and liability values
$ust be adjusted by allocating the difference between cost and book value to s!ecific
recorded or unrecorded tangible and intangible assets and liabilities. 9n the case of a
$ho%%& o$ne subsidiary+ the following two ste!s are taken.
Step One: -(e d%4erence #et3een t(e purc(a.e pr%ce and #oo2 1alue
%. u.ed 5r.t to ad6u.t t(e %nd%1%dual a..et. and l%a#%l%t%e. to t(e%r !a%r
1alue. on t(e date o! ac7u%.%t%on.

Step Two: 9f+ after adjusting identifiable assets and liabilities to fair values+ a residual
a$ount of difference re$ains+ it is treated as follows:
1. :hen cost eceeds the aggregate fair values of identifiable assets less liabilities+ the
residual a$ount will be positive .a debit balance/. 6 !ositive residual difference is evidence
of an uns!ecified intangible and is accounted for as goodwill.
2. :hen the !urchase !rice .ac"uisition cost/ is below the aggregate fair value of
identifiable assets less liabilities+ the residual a$ount will be negative .a credit balance/. 6
negative residual difference is evidence of a bargain !urchase+ with the difference between
ac"uisition cost and fair value designating the a$ount of the bargain.
#
:hen a bargain
ac"uisition occurs+ so$e of the ac"uired assets $ust be reduced below their fair values .as
reflected after ste! 1/.
7he rules are reviewed below for allocating the reduction in the case of a bargain
!urchase. 7hese rules+ which were initially introduced in Cha!ter 2+ reflect an effort to
adjust those assets whose valuation is $ost subjective and leave intact the categories
considered $ost reliable. 6 true bargain is not likely to occur ece!t in situations where
non2"uantitative factors !lay a roleC for ea$!le+ a closely2held co$!any wishes to sell
"uickly because of the health of a fa$ily $e$ber. 9n addition to the recent changes
affecting goodwill a$orti=ation+ the @6>D has also revised the accounting for bargain
!urchases. 7he rules under current E66- are !resented below.
3
8ote t(at t(e !ollo3%n+ .%tuat%on %. po..%#le and, tec(n%cally, 3ould #e a #ar+a%n
purc(a.e: $9:"o.t:)9. )ecau.e t(e !a%r 1alue %. (%+(er t(an purc(a.e pr%ce, t(e
#ar+a%n purc(a.e rule. apply, e1en t(ou+( t(e purc(a.e pr%ce %. (%+(er t(an t(e
#oo2 1alue o! t(e underly%n+ e7u%ty. ;n pract%ce t(%. .%tuat%on %. le.. l%2ely to #e
re!erred to a. a #ar+a%n& t(an t(e .%tuat%on 3(ere )9:$9:"o.t. 8onet(ele.. %t %.
t(e copar%.on #et3een $9 and "o.t t(at deter%ne. a #ar+a%n, re+ardle.. o! t(e
le1el o! )9 <#oo2 1alue=.
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9/13/2001 02:48:00 PM
Ba'(ain Ru%es
1. "urrent a..et., lon+,ter %n1e.tent. %n ar2eta#le .ecur%t%e.
<ot(er t(an t(o.e accounted !or #y t(e e7u%ty et(od=, a..et. to
#e d%.po.ed o! #y .ale, de!erred ta> a..et., prepa%d a..et.
relat%n+ to pen.%on or ot(er po.tret%reent #ene5t plan., and
a..ued l%a#%l%t%e. are recorded at !a%r ar2et 1alue al3ay..
2. Any pre1%ou.ly recorded +ood3%ll on t(e .eller?. #oo2. %.
el%%nated <and no ne3 +ood3%ll recorded=.
3. @on+,l%1ed a..et. <%nclud%n+ %n,proce.. re.earc( and
de1elopent and e>clud%n+ t(o.e .pec%5ed %n <1= a#o1e,= are
recorded at !a%r ar2et 1alue %nu. an ad6u.tent !or t(e
#ar+a%n.
4. An e>traord%nary +a%n %. recorded only %n t(e e1ent t(at all lon+,
l%1ed a..et. <ot(er t(an t(o.e .pec%5ed %n <1= a#o1e= are
reduced to Aero <or to t(e noncontroll%n+ port%on, rat(er t(an
Aero, %! t(e .u#.%d%ary %. not 3(olly o3ned=.
:hen needed+ the reduction of noncurrent assets .ece!t invest$ents in long2ter$
$arketable securities/ is $ade in !ro!ortion to their fair values in deter$ining their
assigned values.
%
7his allocation is illustrated later in this cha!ter.
6c"uisitions leading to the recording of goodwill have been far $ore co$$on in
recent years than bargain ac"uisitions. 7he i$!act of goodwill on future earnings has
drawn a great deal of attention with standard2setters ulti$ately lightening the burden by
no longer re"uiring the a$orti=ation of goodwill. . Other ac"uired intangibles with finite
useful lives+ such as franchises+ !atents+ and software+ $ust still be a$orti=ed over their
esti$ated useful lives+ not to eceed forty years. 7he ea$!les !resented in this cha!ter
focus !ri$arily on de!reciable assets and goodwill. Fote+ however+ that other identified
intangibles would be accounted for in the sa$e $anner as de!reciable asssets+ with the
ter$ ;a$orti=ation e!ense< re!lacing the ter$ de!reciation e!ense.
9n the !ast creative alternatives were so$eti$es found to avoid recording and
a$orti=ing goodwill. One such alternative+ which has been alluded to earlier+ was to
e!ense as *esearch and &evelo!$ent .* A &/ a !ortion of the ecess of !urchase !rice
over fair value ac"uired. 7wo decades ago the @6>D re"uired that *A& incurred in the
regular course of business be e!ensed and subse"uently inter!reted the standard to allow
the e!ensing of certain ty!es of *A& transferred in cor!orate ac"uisitions. 7he Doard
went on to state that the *A& e!ense+ or write2off+ a$ount would be based u!on the
a$ount !aid by the ac"uiring fir$ rather than its historical cost to the ac"uired fir$. Dy
allocating large a$ounts to *A& in the !eriod of the ac"uisition+ fir$s take a large one2
ti$e hit to earnings but avoid future re!eated charges. 7his !ractice beca$e increasingly
!o!ular in recent years a$ong high technology fir$s+ drawing the attention of the >EC
and causing the fir$s to co$!lain that they are being singled out for scrutiny. 9n Garch
1444+ the @6>D indicated its intention to re"uire that in2!rocess * A & ac"uired after
so$e i$!le$entation date should be recorded as an asset and a$orti=ed over the !eriod of
4
APB Opinion No. 16 <par. 91=.
4
9/13/2001 02:48:00 PM
e!ected benefit. 7he @6>D subse"uently announced a decision to delay its !roject on in2
!rocess *A& until after the business co$binations !roject was co$!leted.
In the News:
7he >EC isnt inclined to sy$!athi=e. 6gency officials say they are now enforcing $ore
aggressively rules in !lace since 140). ;6s the nu$ber of co$!anies clai$ing larger Hin2
!rocess *A&I write2offs increased in early 1443+ we began to dig dee!er into the
co$!anys a!!raisal assu$!tions+< says >EC Chief 6ccountant Lynn 7urner. 6t issue is
the si=e of write2offs that co$!anies take for the !re$iu$s they !ay when ac"uiring other
co$!anies+ !articularly high2tech concerns.... Duyers of technology have ca!itali=ed on a
rule that lets the$ take a large one2ti$e write2off for the value of as2yet2undevelo!ed
!roducts they !ick u!. 7he buyers thus avoid incurring re!eated s$all charges that can
de!ress earnings for years.
)

CASE ONE# Acquisition Cost )in E*cess o+, Fai' Va%ue o+ Ienti+ia!%e Net Assets o+
a Su!siia'&
7o illustrate the allocation of the difference between cost and book value to
individual assets and liabilities of a subsidiary+ assu$e that on January 1+ 2''%+ > Co$!any
has ca!ital stock and retained earnings of 81+)''+''' and 8)''+'''+ res!ectively+ and
identifiable assets and liabilities as !resented in 9llustration )21.
9nsert 9llustration )21 here
Adustment of Assets and "iabilities: #holly $wned Subsidiaries
6ssu$e further that - Co$!any ac"uires a 1''( interest in > Co$!any on January 1+
2''%+ for 82+0)'+'''.
7he Co$!utation and 6llocation >chedule would a!!ear as follows:
Co$!utation and 6llocation of &ifference between Cost and Dook Kalue
Cost of 9nvest$ent .!urchase !rice/ 82+0)'+'''
Dook Kalue of E"uity 6c"uired
.82+'''+''' 1''(/ 2+'''+'''
&ifference between Cost and Dook Kalue 0)'+'''
6djust inventory u!ward .assu$e @9@O/ .)'+'''/
6djust e"ui!$ent u!ward .with re$aining life of 1' years/ .#''+'''/
6djust land u!ward .1)'+'''/
Dalance 2)'+'''
*ecord goodwill 2)'+'''
Dalance 8 '
B
*%+(,-ec( $%r. /p.et 01er S'" "rac2do3n,& #y M%c(ael Sc(roeder, CSD, 2/1/99,
p. )4.
B
9/13/2001 02:48:00 PM
7he consolidated state$ents work!a!er entry to eli$inate the invest$ent balance on
January 1+ 2''%+ will result in a debit to the difference between cost and book value in the
a$ount of 80)'+''' as follows:
Ca!ital >tock 2 > Co$!any 1+)''+'''
*etained Earnings 2 > Co$!any )''+'''
&ifference Detween Cost and Dook Kalue 0)'+'''
9nvest$ent in > Co$!any 2+0)'+'''
*eferring to the Co$!utation and 6llocation >chedule+ the work!a!er entry to allocate
the difference between cost and book value to s!ecific consolidated assets takes the
following for$:
9nventory )'+'''
E"ui!$ent .net/ #''+'''
Land 1)'+'''
Eoodwill 2)'+'''
&ifference Detween Cost and Dook Kalue 0)'+'''
7he a$ount of the difference between cost and book value that is not allocated to s!ecific
identifiable assets and liabilities of the subsidiary is recogni=ed as goodwill. 6s defined
earlier+ goodwill is the ecess of ac"uisition cost over the !arent co$!anyLs e"uity in the
fair value of the identifiable net assets of the subsidiary on the ac"uisition date
H82+0)'+''' M 1''(.82+)''+'''/ N 82)'+'''I.
Adustment of Assets and "iabilities% "ess than #holly $wned Subsidiaries
:hen - Co$!any echanges 82+0)'+''' for a 1''( interest in > Co$!any+ the
i$!lication is that the fair value of the net assets+ including uns!ecified intangible assets+ of
> Co$!any is 82+0)'+'''. 6s illustrated above+ if the recorded book value of those net
assets is 82+'''+'''+ adjust$ents totaling 80)'+''' are $ade to s!ecific assets and
liabilities+ including goodwill+ in the consolidated financial state$ents+ serving to recogni=e
the total i$!lied fair value of the subsidiary assets and liabilities.
6ssu$e now that rather than ac"uiring a 1''( interest for 82+0)'+'''+ - Co$!any
!ays 82+2''+''' for an 3'( interest in > Co$!any. 7he fair value of the net assets+
including uns!ecified intangible assets+ of > Co$!any i$!lied by this transaction is still
82+0)'+''' .82+2''+'''O.3'/+ and the i$!lication re$ains that the net assets+ including
uns!ecified intangible assets+ of > Co$!any are understated by 80)'+'''. 9n the case of a
less than wholly owned subsidiary+ however+ current !ractice restricts the write2u! of the
net assets of > Co$!any in the consolidated financial state$ents to the a-ount actua%%&
.ai !& P Co-.an& in e*cess o+ the !oo/ 0a%ue o+ the inte'est it acqui'es+ or
8,''+''' H82+2''+''' 2 .3'.82+'''+'''/ N 8,''+'''I.
7hus+ consolidated net assets are written up only by an amount equal to the parent
company's share of the difference on the date of ac"uisition between the i$!lied fair value
and the book value of the subsidiary co$!anyLs net assets ..3' 80)'+''' N 8,''+'''/.
6s before+ any re$aining a$ount is allocated to goodwill.
E
9/13/2001 02:48:00 PM
9n the event of a bargain !urchase in the case where a non2controlling interest eists+
the bargain !urchase rules are $odified only slightly+ as follows:
a. 6ny !reviously recorded goodwill on the sellers books is eli$inated ece!t for the
noncontrolling interest+ which re$ains on the books.
b. 9n the event that all long2lived assets .other than invest$ents/ are reduced to the
noncontrolling interest .rather than to =ero/+ an extraordinary gain is recogni=ed in
the !eriod of the ac"uisition.
7o illustrate the eistence of a noncontrolling interest in the contet of+ first+ a positive
difference between cost and book value and+ later+ a negative difference+ refer again to
9llustration )21.
6ssu$e first that - Co$!any ac"uires an 3'( interest in > Co$!any for 82+2''+'''.
7he Co$!utation and 6llocation >chedule is !re!ared in 9llustration )22.
9n this case+ goodwill is e"ual to the ecess of ac"uisition cost over the !arent
co$!anyLs e"uity in the fair value of the identifiable net assets of the subsidiary
H82+2''+''' 2 .3'.82+)''+'''/ N 82''+'''I. 7he following entries to eli$inate the
invest$ent and to allocate the difference between cost and book value are worksheet only
entries:
*etained Earnings 2 > Co$!any ..3'/.8)''+'''/ %''+'''
Ca!ital >tock 2 > Co$!any ..3'/.81+)''+'''/ 1+2''+'''
&ifference Detween Cost and Dook Kalue ,''+'''
9nvest$ent in > Co$!any 2+2''+'''
*eferring to the Co$!utation and 6llocation >chedule+ the work!a!er entry to allocate
the difference between cost and book value is:
9nventory %'+'''
E"ui!$ent .net/ 2%'+'''
Land 12'+'''
Eoodwill 2''+'''
CASE TWO# Acquisition Cost )Less Than, Fai' Va%ue o+ Ienti+ia!%e Net Assets o+ a
Su!siia'&1 "ess than #holly $wned Subsidiaries
*efer to 9llustration )21 and assu$e that - Co$!any ac"uires an 3'( interest in >
Co$!any for 81+4''+'''. 7he difference between cost and boo& value is 8#''+'''
H81+4''+''' 2 .3'.82+'''+'''/I. 5owever+ the !arent co$!anyLs interest in the fair value
of the identifiable net assets of the subsidiary H.3'.82+)''+'''/ N 82+'''+'''I eceeds
ac"uisition cost by 81''+'''. 7he Co$!utation and 6llocation >chedule is started as
usual+ but a negative balance re"uires a subse"uent reduction to the adjusted values of
long2lived assets.
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9/13/2001 02:48:00 PM
Co$!utation and 6llocation of &ifference between Cost and Dook Kalue of E"uity
Cost of 9nvest$ent .-urchase -rice/ 81+4''+'''
.82+'''+''' 3'(/ 1+,''+'''
&ifference between Cost and Dook Kalue #''+'''
9ncrease to fair value .by !ro!ortion owned/:
9nventory ..3'8)'+'''/ .%'+'''/
E"ui!$ent ..3'8#''+'''/ .2%'+'''/
Land ..3'81)'+'''/ .12'+'''/ .%''+'''/
Dalance .Ecess of @air Kalue over Cost/ .1''+'''/
&ecrease: .in !ro!ortion to fair values/
E"ui!$ent .,O2' 81''+'''/ #'+'''
Land .%O2' 81''+'''/ 2'+'''
Other Foncurrent 6ssets .1'O2' 81''+'''/ )'+'''
Dalance 8 '
Fote that the reduction of the assets below their adjusted values is recorded in !ro!ortion
to their fair values+ not book values. @or ea$!le+ the total fair value of e"ui!$ent+ land+
and other noncurrent assets e"uals 82+'''+'''. >ince the fair value of e"ui!$ent is
8,''+'''+ the value of e"ui!$ent is reduced by .8,''+'''O82+'''+'''/ or ,O2' ti$es
81''+'''. Fote+ also+ that the reduction does not affect current assets .inventory+ e.g./ and
that it does affect all long2lived assets regardless of whether or not the asset re"uired an
initial adjust$ent .e.g. other noncurrent assets/. Fote+ finally+ that the a$ounts in
!arentheses in the Co$!utation and 6llocation >chedule re"uire debits in the work!a!er
entry .to increase assetsOdecrease liabilities/.
7he a$ounts of the entries to the various asset accounts are obtained by netting any
increase andOor decrease recorded in the Co$!utation and 6llocation >chedule as follows:
Fet 9ncrease
6ccount 9ncrease &ecrease .&ecrease/
9nventory 8%'+''' ' 8%'+'''
E"ui!$ent 2%'+''' #'+''' 21'+'''
Land 12'+''' 2'+''' 1''+'''
Other Foncurrent ' )'+''' .)'+'''/
7otal 8%''+''' 81''+''' 8#''+'''
7he work!a!er entries to eli$inate the invest$ent account and to allocate the difference
between cost and book value $ay be su$$ari=ed in general journal for$ as follows:
*etained Earnings 2 > Co$!any %''+'''
Ca!ital >tock 2 > Co$!any 1+2''+'''
&ifference Detween Cost and Dook Kalue #''+'''
9nventory %'+'''
E"ui!$ent .net/ 21'+'''
Land 1''+'''
Other Foncurrent 6ssets )'+'''
8
9/13/2001 02:48:00 PM
&ifference Detween Cost and Dook Kalue #''+'''
Cost %ess than Boo/ Va%ue %ess than Fai' Va%ue o+ Ienti+ia!%e Net Assets
9t is !ossible for ac"uisition cost to be less than the !arent co$!anyLs interest in the
book value as well as in the fair value of the net assets of the subsidiary. 9n that case+ the
difference between cost and book value initially will be credited in the invest$ent
eli$ination work!a!er entry. 7he analysis of the allocation of this credit balance+ however+
takes the sa$e for$ as that just illustratedC that is+ we begin by adjusting assets u!ward
first and then deter$ine the necessary decreases subse"uently. @or ea$!le+ refer to
9llustration )21 and assu$e that - Co$!any ac"uired an 3'( interest in > Co$!any on
January 1+ 2''%+ for 81+)''+'''.
Cost of 9nvest$ent .-urchase -rice/ 81+)''+'''
.82+'''+''' 3'(/ 1+,''+'''
&ifference between Cost and Dook Kalue .1''+'''/
9ncrease to fair value .by !ro!ortion owned/:
9nventory ..3'8)'+'''/ .%'+'''/
E"ui!$ent ..3'8#''+'''/ .2%'+'''/
Land ..3'81)'+'''/ .12'+'''/ .%''+'''/
Dalance .Ecess of @air Kalue over Cost/ .)''+'''/
&ecrease: .in !ro!ortion to fair values/
E"ui!$ent .,O2' 8)''+'''/ 1)'+'''
Land .%O2' 8)''+'''/ 1''+'''
Other Foncurrent 6ssets .1'O2' 8)''+'''/ 2)'+'''
Dalance '
Fetting the increases against the decreases in the various accounts yields the a$ounts
needed in the journal entry+ as shown below.
9
9/13/2001 02:48:00 PM
Fet 9ncrease
6ccount 9ncrease &ecrease .&ecrease/
9nventory 8%'+''' ' 8%'+'''
E"ui!$ent 2%'+''' 1)'+''' 4'+'''
Land 12'+''' 1''+''' 2'+'''
Other Foncurrent ' 2)'+''' .2)'+'''/
7otal 8%''+''' 8)''+''' .81''+'''/
9F>E*7 9llustration )2#
7he work!a!er entries to eli$inate the invest$ent account and to allocate the
difference between cost and book value are !resented below in general journal for$.
Ca!ital >tock 2 > Co$!any 1+2''+'''
*etained Earnings 2 > Co$!any %''+'''
&ifference Detween Cost and Dook Kalue 1''+'''
9nvest$ent in > Co$!any 1+)''+'''
&ifference Detween Cost and Dook Kalue 1''+'''
9nventory %'+'''
E"ui!$ent .net/ 4'+'''
Land 2'+'''
Other Foncurrent 6ssets 2)'+'''
EFFECT OF ALLOCATION AND DEPRECIATION OF DIFFERENCE
BETWEEN COST AND BOOK VALUE ON CONSOLIDATED NET INCO2E#
Su!sequent to Acquisition
&e!reciation and a$orti=ation in the consolidated inco$e state$ent should be based on
the values allocated to de!reciable and a$orti=able assets in the consolidated balance
sheet. :hen any !ortion of the difference between cost and book value is allocated to such
assets+ recorded inco$e $ust be adjusted in deter$ining consolidated net inco$e in
current and future !eriods. This a3ust-ent is neee to 'e+%ect the i++e'ence !et$een
the a-ount o+ a-o'ti4ation an5o' e.'eciation 'eco'e !& the su!siia'& an the
a..'o.'iate a-ount !ase on conso%iate ca''&in( 0a%ues.
7o illustrate+ assu$e that on January 1+ 2''%+ - Co$!any ac"uires an 3'( interest in
> Co$!any for 82+2''+'''+ at which ti$e > Co$!any has net assets of 82+'''+''' as
!resented in 9llustration )21. 6s !reviously shown in 9llustration )22+ the difference
between cost and book value in the a$ount of 8,''+''' is allocated as follows:
9nventory 8 %'+'''
E"ui!$ent .net/ 2%'+'''
Land 12'+'''
Eoodwill 2''+'''
&ifference Detween Cost and Dook Kalue 8,''+'''
10
9/13/2001 02:48:00 PM
6 co$!arison of the recorded and consolidated carrying values of the assets and liabilities
of > Co$!any on January 1+ 2''%+ is !resented in 9llustration )2%.
9nsert 9llustration )2%
6ssu$e now that all the inventory is sold during 2''%+ that the e"ui!$ent has a
re$aining life of 1' years fro$ January 1+ 2''%. 6djust$ents in the co$!utation of
consolidated net inco$e that result fro$ the allocation and de!reciation of the difference
between cost and book value are su$$ari=ed in 9llustration )2).
9nsert 9llustration )2)
6s a result of the sale of the inventory in 2''%+ > Co$!any will include 8#''+''' in
cost of goods sold+ whereas fro$ a consolidated !oint of view the cost of goods sold
should be 8#%'+''' .inventory fro$ 9llustration )2%/. 5ence+ recorded cost of goods sold
$ust be increased by 8%'+''' in deter$ining consolidated net inco$e in 2''%. 7his
adjust$ent is necessary only in the year.s/ the inventory is sold.
> Co$!any will record on its books 8#'+''' .8#''+'''O1' years/ in de!reciation of
the e"ui!$ent each year. Consolidated annual de!reciation+ however+ should be 8)%+'''
.8)%'+'''O1' years/. 6ccordingly+ de!reciation e!ense $ust be increased each year by
82%+''' in deter$ining consolidated net inco$e. Fote that this a$ount $ay be co$!uted
directly fro$ the Calculation and 6llocation >chedule si$!ly by dividing the adjust$ent to
E"ui!$ent .82%'+'''/ by the re$aining life .1' years/.
Eoodwill arising in the ac"uisition is not recorded by > Co$!any. It remains in the
consolidated balance sheet indefinitely, and it may be adusted only in the event of
impairment. 9n the event of i$!air$ent+ an adjust$ent to recorded inco$e would be
needed to deter$ine consolidated net inco$e. 7he allocation of a !ortion of the difference
between cost and book value to land does not re"uire an adjust$ent to recorded inco$e in
deter$ining consolidated net inco$e+ since land is not a de!reciable .or a$orti=able/
asset.
7he worksheet entries needed to insure that all balance sheet and inco$e state$ent
accounts reflect the correct consolidated balances differ de!ending on which $ethod the
!arent co$!any uses to account for its invest$ent: co$!lete e"uity+ !artial e"uity+ or cost.
7he correct consolidated balances will not differ+ only the $eans of arriving at the$.
7hus+ after the worksheet entries are $ade+ the resulting balances should be identical
under the three $ethods.
Guch of the consolidating !rocess is the sa$e for all three $ethods+ but i$!ortant
differences eist. Each of the following stand2alone sections !resents the entire !rocess.
@or those who are interested in focusing on only one or two of the three $ethods+ the
other sections $ay be o$itted without loss of continuity. @irst+ though+ it is worth noting
that there are only three basic accounts that are re!orted differently in the books of the
!arent. 6 brief review of the entries $ade by the !arent under the three $ethods .see
o!ening of Cha!ter #/ reveals two of these accounts: the invest$ent account itself and the
inco$e recogni=ed fro$ the subsidiary .dividend inco$e or e"uity in subsidiary inco$e/.
>ince the a$ount of inco$e recogni=ed fro$ the subsidiary is added into retained earnings
of the !arent each year+ it follows that the third i$!ortant account that differs a$ong these
$ethods is retained earnings of the !arent.
11
9/13/2001 02:48:00 PM
1nder all three $ethods+ the worksheet entries will se!arate current year effects fro$
the effects of the !revious years because the current year inco$e state$ent accounts are
o!en and need to be re!orted se!arately and correctly. 5ence worksheet entries to
retained earnings will always adjust the balance at the beginning of the current year .or the
date of ac"uisition+ if it is the first year/ under the cost and !artial e"uity $ethods. 1nder
the co$!lete e"uity $ethod+ beginning retained earnings of the !arent is the sa$e as
beginning consolidated retained earnings and hence needs no adjust$ent. @igures )21
through )2# !resent three years of entries for a !arent co$!any and for a consolidating
worksheet under all three $ethods. 9n the following sections+ we e!lain these entries in
detail.
CONSOLIDATED STATE2ENTS WORKPAPER 6 INVEST2ENT RECORDED
USIN7 T8E COST 2ET8OD
9n the !re!aration of consolidated financial state$ents+ the recorded balances of
individual assets+ liabilities+ and e!ense accounts $ust be adjusted to reflect the allocation
and de!reciation+ of the difference between cost and book value. 7hese adjust$ents are
acco$!lished through the use of wor&paper entries in the !re!aration of the consolidated
state$ents work!a!er.
7o illustrate+ assu$e the following:
1. - Co$!any ac"uires an 3'( interest in > Co$!any on January 1+ 2''%+ for
82+2''+'''+ at which ti$e > Co$!any has ca!ital stock of 81+)''+''' and retained
earnings of 8)''+'''. - Co$!any uses the cost $ethod to record its invest$ent in >
Co$!any.
2. 7he allocation of the difference between cost and book value in the a$ount of
8,''+''' H82+2''+''' 2 .3'.82+'''+'''/I is as !reviously !resented in 9llustration )2
)+ includes 8%'+''' to 9nventory+ 82%'+''' to E"ui!$ent .1' year life/+ 812'+''' to
Land+ and 82''+''' to Eoodwill.
#. 9n 2''%+ > Co$!any re!orted net inco$e of 812)+''' and declared and !aid
dividends of 82'+'''.
%. 9n 2'')+ > Co$!any re!orted net inco$e of 81%'+''' and declared and !aid
dividends of 8,'+'''.
). 9n 2'',+ > Co$!any re!orted net inco$e of 82''+''' and declared and !aid
dividends of 80)+'''.
"ea' o+ Acquisition
'ntries on Boo&s of ( )ompany * +,,- - .ear of Ac/uisition
Entries recorded on the books of the - Co$!any under the cost $ethod to reflect the
!urchase of its interest in > Co$!any and the recei!t of dividends in 2''% are as follows:
E*6P DOQ
Cash 2+2''+'''
7o record !urchase of an 3'( interest in > Co$!any.
Cash 1,+'''
12
9/13/2001 02:48:00 PM
&ividend 9nco$e 1,+'''
7o record recei!t of dividends fro$ > Co$!any ..3' 82'+'''/.
#or&paper 'ntries * +,,- 0 .ear of Ac/uisition 1Illustration 2034
7he consolidated state$ents work!a!er for the year ended &ece$ber #1+ 2''%+ is
!resented in 9llustration )2,.
6n analysis of the work!a!er eli$ination entries in 9llustration )2, is !resented here:
DL1E >56&E
.1/ &ividend 9nco$e 1,+'''
&ividends &eclared 1,+'''
7o eli$inate interco$!any dividends.
.2/ Deginning *etained Earnings 2 > Co$!any ..3'
8)''+'''/
%''+'''
Ca!ital >tock 2 > Co$!any ..3' 81+)''+'''/ 1+2''+'''
7o eli$inate the invest$ent account against the e"uity accounts of > Co$!any using
e"uity balances at the beginning of the current year.
.#a/ Cost of Eoods >old .Deginning 9nventory/ %'+'''
E"ui!$ent .net/ .1' year re$aining life/ 2%'+'''
Land 12'+'''
Eoodwill .2' year useful life/ 2''+'''
7o allocate the a$ount of difference between cost and book value at date of ac"uisition to
s!ecific assets and liabilities .see 9llustration )22/.
Dy the end of the first year+ under a @9@O .first2in+ first2out/ cost flow assu$!tion+ the
inventory that necessitated the 8%'+''' adjust$ent would have been sold. *ecall that at
the date of ac"uisition+ this adjust$ent was to 9nventory. 6t the end of the first year+
however+ the entry is to Cost of Eoods >old .or to Deginning 9nventory+ as a sub2
co$!onent of the Cost of Eoods >old/. >ince > Co$!any will not have included the
additional 8%'+''' allocated to inventory in its re!orted Cost of Eoods >old .COE>/+
consolidated Cost of Eoods >old $ust be increased by this work!a!er entry. 9f the
inventory were still on hand on &ece$ber #1+ 2''% .for ea$!le+ if a L9@O flow were
assu$ed/+ the 8%'+''' would be allocated to ending inventory in the balance sheet rather
than to Cost of Eoods >old.
7his entry to Cost of Eoods >old is a!!ro!riate only in the year of ac"uisition. 9n
subse"uent years+ consolidated Cost of Eoods >old will have been reflected in the 2''%
consolidated net inco$e and hence consolidated retained earnings at the end of 2''%.
7hus+ the adjust$ent .8%'+''' debit/ in future years will be to Deginning *etained
Earnings2 - Co$!any.
.#b/ &e!reciation E!ense .82%'+'''O1'
years/
2%+'''
E"ui!$ent .net/
,
2%+'''
13
9/13/2001 02:48:00 PM
7o de!reciate the a$ount of difference between cost and book value allocated to
e"ui!$ent .see 9llustration )2)/.
6s !reviously noted+ de!reciation in the consolidated inco$e state$ent should be based
on the value assigned to the e"ui!$ent in the consolidated balance sheet. >ince the
de!reciation recorded by > Co$!any is based on the book value of the e"ui!$ent on its
records+ consolidated de!reciation $ust be increased by a work!a!er entry.
7he a$ount of the difference between cost and book value not allocated to s!ecific
identifiable assets or liabilities is treated in the consolidated financial state$ents as
goodwill. -reviously+ goodwill was a$orti=ed .using the straight2line $ethod/ over an
a!!ro!riate !eriod not to eceed %' years. 5owever+ under @6>Ds latest !ronounce$ent
on business co$binations+ co$!anies are not currently re"uired to a$orti=e goodwill.
9nstead it is adjusted only when i$!aired.
9t is !ossible+ of course+ to co$bine the work!a!er entries relating to the allocation+
and de!reciation of the difference between cost and book value into one entry. 9n
9llustration )2,+ for ea$!le+ work!a!er entries .#a/ and .#b/ could be !resented in one
co$bined entry as follows:
.#/ Cost of Eoods >old .Deginning 9nventory/ %'+'''
&e!reciation E!ense 2%+'''

E"ui!$ent .net/ .82%'+''' 2 82%+'''/ 21,+'''
Land 12'+'''
Eoodwill 2''+'''
9nsert 9llustration )2,
9n 9llustration )2,+ the calculation of noncontrolling interest is not affected by the
de!reciation of the differences between cost and book value. >ince the differences between
cost and book value re!resent a cost incurred by the !arent co$!any in the !urchase of
the subsidiary stock+ its de!reciationOa$orti=ation is charged in its entirety to the !arent
co$!any .controlling stockholders/ under current generally acce!ted accounting !rinci!les
.E66-/.
"ea' Su!sequent to Acquisition
'ntries on Boo&s of ( )ompany * +,,2 0 .ear Subse/uent to Ac/uisition
9n 2'')+ - Co$!any will record dividend inco$e as follows:
E*6P DOQ
Cash %3+'''
&ividend 9nco$e %3+'''
7o record recei!t of dividends fro$ > Co$!any
..3 8,'+'''/.
E
-(e cred%t to t(%. entry could al.o #e accuulated deprec%at%on.
14
9/13/2001 02:48:00 PM
1nder the Cost Gethod+ the !arent co$!any $akes no entry for the re!orted inco$e of
the subsidiary.
#or&paper 'ntries * +,,2 0 .ear Subse/uent to Ac/uisition 1Illustration 2054
7he consolidated state$ents work!a!er for the year ended &ece$ber #1+ 2'') is
!resented in 9llustration )20.
9F>E*7 9llustration )20 here
:ork!a!er eli$ination entries in 9llustration )20 are !resented in general journal for$ as
follows:
DL1E >56&E
.1/ 9nvest$ent in > Co$!any 3%+'''
Deginning *etained Earnings 2 - Co$!any 3%+'''
7o convert to e"uityOestablish reci!rocity as of 1O1O') H.8,')+''' 2 8)''+'''/ .3'I.
7his entry re!resents the change in retained earnings of > Co$!any fro$ the date
of ac"uisition to the beginning of the current year. 7his also converts retained earnings to
the value that would be recorded if the !artial e"uity $ethod had been used.
.2/ &ividend 9nco$e %3+'''
&ividends &eclared %3+'''
7o eli$inate the interco$!any dividends.
.#/ Deginning *etained Earnings 2 > Co$!any
..3' 8,')+'''/ %3%+'''
Ca!ital >tock 2 > Co$!any
..3' 81+)''+'''/ 1+2''+'''
9nvest$ent in > Co$!any
.82+2''+''' R 83%+'''/ 2+23%+'''
7o eli$inate the invest$ent account against the e"uity accounts of > Co$!any using
e"uity balances at the beginning of the current year.
9n the invest$ent eli$ination entry+ the a$ount debited or credited to the
&ifference between Cost and Dook Kalue $ay be treated as a !lug figure to balance the
entry and is e"ual to the a$ount of the difference between cost and book value on the date
of ac"uisition. 7he a$ount does not change subse"uent to ac"uisition and $ay be
obtained fro$ the Co$!utation and 6llocation >chedule .9llustration )22/.
:ork!a!er entry .%/ is !resented net+ first in a co$bined single entry and then
.alternatively/ in its co$!onents. 7he authors find the second a!!roach .co$!onents/
easier to understand+ though less s!ace efficient.
.%/ Deginning *etained Earnings 2 - Co$!any
.Deginning Consolidated *etained Earnings/
.%'+'''R2%+'''/

,%+'''
&e!reciation E!ense .82%'+'''O1'/ 2%+'''
1B
9/13/2001 02:48:00 PM
E"ui!$ent .net/ .82%'+''' 2 82%+''' 2 82%+'''/ 142+'''
Land 12'+'''
Ecess of Cost over @air Kalue
.82''+''' 2 / 2''+'''
7o allocate and de!reciate the difference between cost and book value.
Be(innin( conso%iate 'etaine ea'nin(s -ust !e a3uste each &ea' +o' the
cu-u%ati0e a-ount o+ e.'eciation an othe' euctions that ha0e !een -ae +'o-
conso%iate net inco-e !ecause o+ the e.'eciation o+ the i++e'ence !et$een cost
an !oo/ 0a%ue in the conso%iate state-ents $o'/.a.e's o+ .'io' &ea's. Dy
reducing !reviously re!orted consolidated net inco$e+ these work!a!er adjust$ents also
reduce !reviously re!orted consolidated retained earnings. 7he reduction of beginning
consolidated retained earnings is acco$!lished by a debit to the beginning retained
earnings of the !arent co$!any in the consolidated state$ents work!a!er. 7he 8,%+'''
debit to beginning retained earnings is e"ual to the 8%'+''' charged to cost of goods sold
!lus the 82%+''' charged to de!reciation e!ense. :here !art of the difference between
cost and book value is allocated to de!reciable assets+ the work!a!er adjust$ent to the
beginning retained earnings of the !arent co$!any will beco$e !rogressively larger each
year.
7o se!arate the above entry into its $ore digestible co$!onents+ begin with the
allocation of the difference between cost and book value and then !roceed to record
ecess de!reciation as follows:
.%a/ Deginning *etained Earnings M - Co$!any
.!revious years cost of goods sold/

%'+'''
E"ui!$ent .net/ 2%'+'''
Land 12'+'''
Eoodwill 2''+'''
Entry .%a/ is identical to that recorded in the !receding year+ with the ece!tion that
the entry to Cost of Eoods >old is a!!ro!riate only in the year of ac"uisition. 7hus+ the
adjust$ent in year 2 .and future years/ is to Deginning *etained Earnings.
.%b/ &e!reciation E!ense .current year/ 2%+'''
Deginning *etained Earnings M - Co$!any .!revious
years de!reciation e!ense/ 2%+'''
E"ui!$ent .net/ or 6ccu$ulated &e!reciation %3+'''
e"ui!$ent.
7his entry differs fro$ the first year entry in that the ecess de!reciation fro$ the year
2''% is now reflected in Deginning *etained Earnings2 - Co$!any. 6lthough the
adjust$ent to E"ui!$ent .net/ was already $ade in the !rior year work!a!er for one
years de!reciation adjust$ent+ it was not !osted to the books of > Co$!any and hence
$ust be $ade again. 9f the following year .2'',/ were being !resented+ the debit to
1E
9/13/2001 02:48:00 PM
&e!reciation E!ense would re$ain at 2%+'''+ but the debit to Deginning *etained
Earnings would be %3+''' to reflect two !rior years of ecess de!reciation .and the credit
to Fet E"ui!$ent would total 02+'''/.
.%c/

Clearly+ if entries .%a/ and .%b/ are recorded se!arately+ the co$bined entry .%/ is not
needed.
7he a$ounts charged to e!ense each year were calculated in 9llustration )2). >ince
inventory was sold in 2''%+ no !art of the difference between cost and book value is
allocated to inventory in the years after its sale. 7he a$ounts allocated to assets and
liabilities are the unde!reciated a$ounts at the end of the year. 7hus+ the a$ounts
allocated to de!reciable assets and liabilities in the balance sheet will beco$e !rogressively
s$aller each year.
9n the third year after ac"uisition .&ece$ber #1+ 2'',/+ consolidated state$ents
work!a!er+ for ea$!le+ the work!a!er eli$ination entry will be as follows .if co$bined
into one entry/:
Deginning *etained Earnings 2 - Co$!any
.Deginning Consolidated *etained Earnings/
.8,%+''' R 82%+'''/ 33+'''
E"ui!$ent .net/
.82%'+''' 2 82%+''' 2 82%+''' 2 82%+'''/ 1,3+'''
Land 12'+'''
Eoodwill 2''+'''
7he debit to the beginning retained earnings of the !arent co$!any in 2'', .8,%+''' R
82%+''' N 833+'''/ is e"ual to the a$ount by which consolidated net inco$e and
consolidated retained earnings have been reduced because of the allocation and
de!reciation of the difference between cost and book value in the 2''% .8%'+''' R
82%+''' N 8,%+'''/ and 2'') .82%+'''/ consolidated state$ents work!a!ers Hsee
illustration )2)C also see entries .#a and #b/ in 9llustration )2, and entries .%b/ in
9llustration )20I. 7his entry can also be si$!lified by breaking it into its co$!onents.
@igure )21 !resents the entries in their se!arate co$!onents for all three years side by
side for the cost $ethod.
COST 2ET8OD ANAL"SIS OF CONTROLLIN7 AND NON6CONTROLLIN7
INTERESTS IN CO2BINED INCO2E AND RETAINED EARNIN7S
9n the !receding cha!ter a t2account a!!roach to the calculation of consolidated net
inco$e .or the controlling interest in co$bined inco$e as well as the non2controlling
interest in co$bined inco$e/ was !resented. 7his a!!roach $ust now be refined to
17
9/13/2001 02:48:00 PM
acco$$odate the effect of the allocation and de!reciation of the difference between cost
and book value.
)onsolidated net income is the parent company6s income from its independent
operations plus 1minus4 its share of reported subsidiary income 1loss4 plus or minus
adustments for the period relating to the depreciation7amortization of the difference
between mar&et and boo& value
7he calculation of controlling and non-controlling interests in combined income for
the year ended &ece$ber #1+ 2'')+ !resented in 9llustration )23 is based on 9llustration )2
0. 7his+ of course+ is the sa$e a$ount of consolidated net inco$e as that calculated in the
consolidated financial state$ents work!a!er.
9nsert illustration )23 here
)onsolidated retained earnings is the parent company6s cost basis retained earnings
plus 1minus4 the parent company6s share of the increase 1decrease4 in reported
subsidiary retained earnings from the date of ac/uisition to the current date plus or
minus the cumulative effect of adustments to date relating to the depreciation7
amortization of the difference between mar&et and boo& value.
7he calculation of consolidated retained earnings on &ece$ber #1+ 2'')+ !resented in
9llustration )24 is based on 9llustration )20. 7his is the sa$e a$ount of consolidated
retained earnings as that shown in the consolidated state$ents work!a!er !resented in
9llustration )20+ and $ay be used as a $eans of checking the balance.
6lternatively+ consolidated retained earnings can be co$!uted by adding beginning
consolidated retained earnings to consolidated net inco$e and subtracting dividends
declared by Co$!any -.
Deginning Consolidated *etained Earnings 81+313+'''
-lus: Consolidated Fet 9nco$e %,4+'''
Less: &ividends &eclared by - Co$!any .1)'+'''/
Ending Consolidated *etained Earnings 82+1#0+'''
9F>E*7 9llustration )24 here
USIN7 PARTIAL E9UIT" 2ET8OD
9n the !re!aration of consolidated financial state$ents+ the recorded balances of individual
assets+ liabilities+ and e!ense accounts $ust be adjusted to reflect the allocation and
de!reciation of the difference between cost and book value.
6lthough the e"uity $ethods .!artial and co$!lete/ reflect the effects of certain
transactions $ore fully than the cost $ethod on the books of the !arent+ the adjust$ents
have not been $ade to individual underlying asset or inco$e state$ent accounts. @or
ea$!le+ under the !artial e"uity $ethod+ the !arent records its e"uity in subsidiary
inco$e in its books+ but it does not record the underlying revenue and e!ense accounts
that co$bine to for$ that total. 6lso+ under this $ethod+ the !arent does not record
18
9/13/2001 02:48:00 PM
ecess de!reciation or a$orti=ation of identifiable intangibles arising in the ac"uisition in
its invest$ent account. 7hese adjust$ents $ust be acco$!lished through the use of
wor&paper entries in the !re!aration of the consolidated state$ents work!a!er.
earnings of 8)''+'''. - Co$!any uses the !artial e"uity $ethod to record its
invest$ent in > Co$!any.
'ntries on Boo&s of ( )ompany * +,,- 0 .ear of Ac/uisition
Entries recorded on the books of - Co$!any under the !artial e"uity $ethod are as
follows:
E*6P DOQ
.1/ 9nvest$ent in > Co$!any 2+2''+'''
Cash 2+2''+'''
7o record !urchase of 3'( interest in > Co$!any.
.2/ Cash 1,+'''
9nvest$ent in > Co$!any 1,+'''
7o record dividends received ..3' 82'+'''/.
.#/ 9nvest$ent in > Co$!any 1''+'''
E"uity in >ubsidiary 9nco$e 1''+'''
7o record e"uity in subsidiary inco$e
..3' 812)+'''/.
'ntries on Boo&s of ( )ompany * +,,2 0 .ear Subse/uent to Ac/uisition
E*6P DOQ
.%/ Cash %3+'''
9nvest$ent in > Co$!any %3+'''
7o record dividends received ..3' 8,'+'''/.
.)/ 9nvest$ent in > Co$!any 112+'''
E"uity in >ubsidiary 9nco$e 112+'''
19
9/13/2001 02:48:00 PM
..3' 81%'+'''/.
6fter these entries are !osted+ the 9nvest$ent account will a!!ear as follows:
9FKE>7GEF7 9F > COG-6FP
.1/ Cost 2+2''+''' .2/ &ividends 1,+'''
.#/ >ubsidiary 9nco$e 1''+'''
12O#1O'% Dalance 2+23%+'''
.)/ >ubsidiary 9nco$e 112+''' .%/ &ividends %3+'''
12O#1O') Dalance 2+#%3+'''
#or&paper 'ntries * +,,- * .ear of Ac/uisition
6 consolidated state$ents work!a!er under the !artial e"uity $ethod for the year ended
&ece$ber #1+ 2''%+ is !resented in 9llustration )21'.
9nsert 9llustration )21' here.
:ork!a!er entries in 9llustration )21' are !resented in general journal for$ as follows:
DL1E >56&E
.1/ Deginning *etained Earnings 2 >
Co$!any ..3' 8)''+'''/ %''+'''
..3' 81+)''+'''/ 1+2''+'''

7o eli$inate invest$ent account against the e"uity accounts of > Co$!any at the date of
ac"uisition.
DL1E >56&E
.2a/ Cost of Eoods >old .Deginning 9nventory/ %'+'''
E"ui!$ent .net/ 2%'+'''
Land 12'+'''
Eoodwill 2''+'''
inventory which necessitated the 8%'+''' adjust$ent would have been sold. *ecall that at
20
9/13/2001 02:48:00 PM
7his entry to Cost of Eoods >old is a!!ro!riate only in the year of ac"uisition. 9n
subse"uent years+ consolidated COE> will have been reflected in the 2''% consolidated
net inco$e and hence consolidated retained earnings at the end of 2''%. 7hus+ the
adjust$ent .8%'+''' debit/ in future years will be to Deginning *etained Earnings M -
Co$!any.
DL1E >56&E
.2b/ &e!reciation E!ense 2%+'''
E"ui!$ent .net/ or accu$ulated de!reciation 2%+'''
e"ui!$ent .82%'+'''O1' yearsC see 9llustration )2)/.
6s !reviously noted+ de!reciation in the consolidated inco$e state$ent should be based
on the value assigned to the e"ui!$ent in the consolidated balance sheet. >ince the
de!reciation recorded by > Co$!any is based on the book value of the e"ui!$ent in its
records+ consolidated de!reciation $ust be increased by a work!a!er entry.
and de!reciation of the difference between cost and book value into one entry. 9n
9llustration )21'+ for ea$!le+ work!a!er entries .2a/ and .2b/ could be !resented in one
co$bined entry as follows:
DL1E >56&E
.2/ Cost of Eoods >old .Deginning 9nventory/ %'+'''
E"ui!$ent .net/ .82%'+''' 2 82%+'''/ 21,+'''
Land 12'+'''
Eoodwill 2''+'''
7his co$bined entry is not needed if entries .2a/ and .2b/ are $ade individually.
Fet+ the work!a!er entries to reverse the effect of !arent co$!any entries during the
year for subsidiary dividends and inco$e $ay be se!arated to record the reversal of
dividends in one entry and the reversal of inco$e in another+ as follows .and as shown in
9llustration )21'/:
DL1E >56&E
.#a/ E"uity in >ubsidiary 9nco$e 1''+'''
9nvest$ent in > Co$!any 1''+'''

7o reverse the effect of subsidiary inco$e recogni=ed in the books of the !arent.
DL1E >56&E
.#b/ 9nvest$ent in > Co$!any 1,+'''

7o reverse the effect of dividends declared by the subsidiary and received by the !arent.
21
9/13/2001 02:48:00 PM
6lternatively+ the effects of entries .#a/ and .#b/ $ay be co$bined into one entry+ as
shown below:
DL1E >56&E
.#/ E"uity in >ubsidiary 9nco$e 1''+'''
9nvest$ent in > Co$!any 3%+'''
7o reverse the effect of !arent co$!any entries during the year for subsidiary dividends
and inco$eC not needed if entries .#a/ and .#b/ are $ade individually.
7he calculation of noncontrolling interest in 9llustration )21' is not affected by the
a$orti=ationOde!reciation of the differences between cost and book value. >ince the
differences between cost and book value re!resent a cost incurred by the !arent co$!any
in the !urchase of the subsidiary stock+ its de!reciationOa$orti=ation is charged in its
entirety to the !arent co$!any .controlling stockholders/ under current generally acce!ted
accounting !rinci!les .E66-/.
Wo'/.a.e' Ent'ies : ;<<5 6 "ea' Su!sequent to Acquisition : Pa'tia% Equit&
2etho
Fet+ a consolidated state$ents work!a!er under the !artial e"uity $ethod for the
year ended &ece$ber #1+ 2'')+ is !resented in 9llustration )211.
9nsert 9llustration )211 here.
:ork!a!er entries in 9llustration )211 are !resented in general journal for$ as follows:
DL1E >56&E .kee! entry togetherOon sa$e !age/
Co$!any ..3' 8,')+'''/ %3%+'''
..3' 81+)''+'''/ 1+2''+'''
&ifference Detween Cost and Dook
Kalue

,''+'''
9nvest$ent in > Co$!any 2+23%+'''

7o eli$inate invest$ent account against the e"uity accounts of > Co$!any using e"uity
balances at the beginning of the current year.
@or those who have read the cost $ethod discussion+ note that une' the .a'tia%
equit& -etho= the'e is no nee to esta!%ish 'eci.'ocit&. 7hat feature was uni"ue to
the cost $ethod+ and in fact $ay be viewed as a sort of conversion to the e"uity $ethod.
9n the invest$ent eli$ination entry+ the a$ount debited or credited to the &ifference
between Cost and Dook Kalue $ay be treated as a !lug figure to balance the entry and is
e"ual to the a$ount of the difference between cost and book value on the date of
ac"uisition. 7he a$ount does not change subse"uent to ac"uisition and $ay be obtained
fro$ the Co$!utation and 6llocation >chedule .9llustration )22/.
22
9/13/2001 02:48:00 PM
:ork!a!er entry .2/ is !resented net+ first in a co$bined single entry and then
.alternatively/ in its co$!onents. 7he authors find the second a!!roach .co$!onents/
easier to understand+ though less co$!act.
.2/ Deginning *etained Earnings 2 - Co$!any
.Deginning Consolidated *etained Earnings/ ,%+'''
E"ui!$ent .net/ .82%'+''' 2 82%+'''
2 82%+'''/

142+'''
Land 12'+'''
Eoodwill 2''+'''
Kalue

,''+'''
DL1E >56&E
.2a/ Deginning *etained Earnings M - Co$!any .!rior years
COE> entry/
%'+'''
E"ui!$ent .net/ 2%'+'''
Land 12'+'''
Eoodwill 2''+'''
s!ecific assets and liabilities .see 9llustration )2)/.
Entry .2a/ is identical to that recorded in the !receding year+ with the ece!tion
that the entry to Cost of Eoods >old is a!!ro!riate only in the year of ac"uisition. 7hus+
the adjust$ent in year 2 .and future years/ is to Deginning *etained Earnings.
DL1E >56&E
.2b/ &e!reciation E!ense .current year/ 2%+'''
Deginning *etained Earnings M - Co$!any
.!rior years de!reciation e!ense/
E"ui!$ent .net/
2%+'''
%3+'''
e"ui!$ent.
7his entry differs fro$ the first year entry in that the ecess de!reciation fro$ the year
2''% is now reflected in Deginning *etained Earnings2 - Co$!any. 6lthough the
adjust$ent to E"ui!$ent was already $ade in the !rior year work!a!er for one years
de!reciation adjust$ent+ it was not !osted to the books of > Co$!any and hence $ust be
$ade again. 9f the following year .2'',/ were being !resented+ the debit to &e!reciation
E!ense would re$ain at 2%+'''+ but the debit to Deginning *etained Earnings would be
%3+''' to reflect two !rior years of ecess de!reciation .and the credit to E"ui!$ent
would total 02+'''/.
23
9/13/2001 02:48:00 PM
Clearly+ if entries .2a/ and .2b/ are recorded se!arately+ the co$bined entry .2/ is
not needed.
DL1E >56&E
.#/ E"uity in >ubsidiary 9nco$e 112+'''
9nvest$ent in > Co$!any ,%+'''
7o reverse the effect of !arent co$!any entries during the year 2'') for subsidiary
dividends and inco$e.
Observe that the consolidated balances in 9llustration )211 are the sa$e as those in
9llustration )20 .cost $ethod work!a!er/. 6 co$!arison of the work!a!er entries to
eli$inate the invest$ent account and to allocate and de!reciate the difference between
cost and book value are the sa$e regardless of whether the invest$ent is recorded using
the cost $ethod or the !artial e"uity $ethod. Only the entries for interco$!any dividends
and inco$e and for reci!rocity differ.
@igure )22 !resents the entries in their se!arate co$!onents for all three years .2''%
through 2'',/ side by side for the !artial e"uity $ethod.
PARTIAL E9UIT" 2ET8OD ANAL"SIS OF CONTROLLIN7 AND
NONCONTROLLIN7 INTERESTS IN CO2BINED NET INCO2E
AND RETAINED EARNIN7S
7he t2account calculation of consolidated net inco$e .or the controlling interest in
co$bined inco$e/ does not differ between the cost and !artial e"uity $ethods. 6s stated
earlier+ consolidated net income is the parent company6s income from its independent
operations plus 1minus4 its share of reported subsidiary income 1loss4 plus or minus
adustments for the period relating to the depreciation7amortization of the difference
between mar&et and boo& value.
7he calculation of consolidated net inco$e for the year ended &ece$ber #1+ 2'')+
!resented in 9llustration )212 is based on 9llustration )211. 7his+ of course+ is the sa$e
a$ount of consolidated net inco$e as that calculated in the consolidated state$ents
work!a!er !resented in 9llustration )211.
:hen the !arent co$!any uses the !artial e"uity $ethod to account for its invest$ent+
the !arent co$!anyLs share of subsidiary inco$e since ac"uisition is already included in the
!arent co$!anyLs re!orted retained earnings. Conse"uently+ consolidated retained
earnings is calculated as the parent company6s recorded partial e/uity basis retained
earnings plus or minus the cumulative effect of the adustments to date relating to the
depreciation7amortization of the difference between mar&et and boo& value.
7he analytical calculation of consolidated retained earnings on &ece$ber #1+ 2'')+
!resented in 9llustration )21# is based on 9llustration )211. 7his+ too+ is the sa$e a$ount
of consolidated retained earnings as that shown in the consolidated state$ents work!a!er
!resented in 9llustration )211.
9nsert 9llustration )21# here
24
9/13/2001 02:48:00 PM
6lternatively+ consolidated retained earnings can be co$!uted by adding beginning
consolidated retained earnings to consolidated net inco$e and subtracting dividends
declared by Co$!any -.
Deginning Consolidated *etained Earnings 81+313+'''
-lus: Consolidated Fet 9nco$e %,4+'''
Less: &ividends &eclared by - Co$!any .1)'+'''/
Ending Consolidated *etained Earnings 82+1#0+'''
USIN7 CO2PLETE E9UIT" 2ET8OD
9n the !re!aration of consolidated financial state$ents+ the recorded balances of
individual assets+ liabilities+ and e!ense accounts $ust be adjusted to reflect the allocation
and de!reciation of the differences between cost and book value.
:hen the !arent accounts for its invest$ent using the co$!lete e"uity $ethod+ the
!arent records ecess de!reciation arising in the ac"uisition in its invest$ent account. 7he
inco$e state$ent effects are recorded as adjust$ents to the a$ount recogni=ed as ;e"uity
in subsidiary inco$e< each year. Even under this $ethod+ however+ adjust$ents are
needed to record the effects in the !ro!er accounts for the consolidated entity. @or
ea$!le+ the account ;e"uity in subsidiary inco$e< will be eli$inated in the consolidated
financial state$ents+ and the effects need to be shown directly in ;de!reciation e!ense.<
>i$ilarly+ the invest$ent account will be eli$inated+ and the adjust$ents for any
differences between cost and book value need to be shown directly in the a!!ro!riate asset
.inventory+ land+ e"ui!$ent+ goodwill+ etc./ andOor liability accounts. 7hese adjust$ents
$ust be acco$!lished through the use of wor&paper entries in the !re!aration of the
consolidated state$ents work!a!er.
earnings of 8)''+'''. - Co$!any uses the co$!lete e"uity $ethod to record its
invest$ent in > Co$!any.
'ntries on Boo&s of ( )ompany * +,,- !.ear of Ac/uisition4 and +,,2 1Subse/uent
.ear4
2B
9/13/2001 02:48:00 PM
Entries recorded on the books of - Co$!any under the co$!lete e"uity $ethod are as
follows:
;<<> : "ea' o+ Acquisition
E*6P DOQ
.1/ 9nvest$ent in > Co$!any 2+2''+'''
Cash 2+2''+'''
7o record !urchase of 3'( interest in > Co$!any.
.2/ Cash 1,+'''
9nvest$ent in > Co$!any 1,+'''
7o record dividends received ..3' 82'+'''/.
.#/ 9nvest$ent in > Co$!any 1''+'''
E"uity in >ubsidiary 9nco$e 1''+'''
..3' 812)+'''/.
.%/ E"uity in >ubsidiary 9nco$e ,%+'''
9nvest$ent in > Co$!any ,%+'''
7o adjust e"uity in subsidiary inco$e for ecess de!reciation .82%+'''/ and the higher
value !laced on inventory and thus on cost of goods sold .8%'+'''/. >ee 9llustration )2).
Entries .#/ and .%/ could be colla!sed into one co$bined entry of 8#,+''' .81''+'''
$inus 8,%+'''/.
;<<5 6 Year Subsequent to Acquisition
E*6P DOQ
.1/ Cash %3+'''
9nvest$ent in > Co$!any %3+'''
7o record dividends received ..3' 8,'+'''/.
.2/ 9nvest$ent in > Co$!any 112+'''
E"uity in >ubsidiary 9nco$e 112+'''
7o record e"uity in subsidiary inco$e ..3' 81%'+'''/.
.#/ E"uity in >ubsidiary 9nco$e 2%+'''
9nvest$ent in > Co$!any 2%+'''
7o adjust e"uity in subsidiary inco$e for ecess de!reciation .82%+'''/.
6gain+ entries .2/ and .#/ could be colla!sed into one co$bined entry of 833+'''
.8112+''' $inus 82%+'''/. Fote also that the inventory adjust$ent was needed only in
the first year under a first2in+ first2out .@9@O/ cost flow assu$!tion.
6fter these entries are !osted+ the 9nvest$ent account will a!!ear as follows:
2E
9/13/2001 02:48:00 PM
9FKE>7GEF7 9F > COG-6FP
.1/ Cost 2+2''+''' .2/ &ividends 1,+'''
.#/ >ubsidiary 9nco$e 1''+''' .%/ Ecess de!reciation+ and
Cost of Eoods >old
,%+'''
12O#1O'% Dalance 2+22'+'''
.2/ >ubsidiary 9nco$e 112+''' .1/ &ividends %3+'''
.#/ Ecess de!reciation
2%+'''
12O#1O') Dalance 2+2,'+'''
#or&paper 'ntries * +,,- 0 .ear of Ac/uisition 1Illustration 208-4
6 consolidated state$ents work!a!er under the co$!lete e"uity $ethod for the
year ended &ece$ber #1+ 2''%+ is !resented in 9llustration )21%.
9nsert 9llustration )21% here
:ork!a!er entries in 9llustration )21% are !resented in general journal for$ as follows:
DL1E >56&E
Co$!any ..3' 8)''+'''/ %''+'''
..3' 81+)''+'''/ 1+2''+'''

7o eli$inate invest$ent account against the e"uity accounts of > Co$!any at the date of
ac"uisition.
DL1E >56&E
.2a/ Cost of Eoods >old .Deginning 9nventory/ %'+'''
E"ui!$ent .net/ 2%'+'''
Land 12'+'''
Eoodwill 2''+'''
inventory which necessitated the 8%'+''' adjust$ent would have been sold. *ecall that at
27
9/13/2001 02:48:00 PM
7his entry to COE> is a!!ro!riate only in the year of ac"uisition. 9n subse"uent
years+ consolidated COE> will have been reflected in the 2''% consolidated net inco$e
and hence consolidated retained earnings at the end of 2''%. On the books of - Co$!any+
the adjust$ent is reflected in e"uity in subsidiary inco$e .and thus in ending retained
earnings/ and in the invest$ent account. Decause the invest$ent account $ust be
eli$inated in the consolidating !rocess+ the entry to COE> is re!laced in future years by
an entry .8%'+''' debit/ to 9nvest$ent in > Co$!anyC this work!a!er entry serves to
facilitate the eli$ination of the invest$ent account by reversing an adjust$ent $ade by the
!arent.
DL1E >56&E
.2b/ &e!reciation E!ense 2%+'''
E"ui!$ent .net/ 2%+'''
e"ui!$ent .82%'+'''O1' yearsC see 9llustration )2)/.
A. pre1%ou.ly noted, deprec%at%on %n t(e con.ol%dated %ncoe
.tateent .(ould #e #a.ed on t(e 1alue a..%+ned to t(e e7u%pent %n
t(e con.ol%dated #alance .(eet. S%nce t(e deprec%at%on recorded #y S
"opany %. #a.ed on t(e #oo2 1alue o! t(e e7u%pent on %t. record.,
con.ol%dated deprec%at%on u.t #e %ncrea.ed #y a 3or2paper entry.
a$orti=ation+ and de!reciation of the difference between cost and book value into one
entry. @or ea$!le+ work!a!er entries .2a/ and .2b/ could be !resented in one co$bined
entry as follows:
DL1E >56&E @O* :O*S-6-E* OFLP EF7*9E>
.2/ Cost of Eoods >old .Deginning 9nventory/ %'+'''
E"ui!$ent .net/ .82%'+''' 2 82%+'''/ 21,+'''
Land 12'+'''
Eoodwill / 2''+'''
7his co$bined entry is not needed if entries .2a/ and .2b/ are $ade individually.
Fet we reverse the effect of !arent co$!any entries during the year for subsidiary
dividends and inco$e. 5ere also entries $ay be co$bined or se!arated to record the
reversal of dividends in one entry+ the reversal of re!orted inco$e in a second entry+ and
the reversal of adjust$ents to subsidiary inco$e in a third.
.#a/ 9nvest$ent in > Co$!any 1,+'''

7o reverse the effect of dividends declared by the subsidiary and received by the !arent.
.#b/ E"uity in >ubsidiary 9nco$e 1''+'''
28
9/13/2001 02:48:00 PM
9nvest$ent in > Co$!any 1''+'''

7o reverse the effect of subsidiary re!orted inco$e recogni=ed in the books of the !arent.
.#c/ 9nvest$ent in > Co$!any ,%+'''
E"uity in >ubsidiary 9nco$e ,%+'''

7o reverse the adjust$ents to subsidiary inco$e recogni=ed by the !arent .8%'+''' cost of
goods sold and 82%+''' de!reciation/.
6lternatively+ the effects of entries .#a/ through .#c/ $ay be co$bined into one
entry+ as shown below:
DL1E >56&E
.#/ E"uity in >ubsidiary 9nco$e #,+'''
9nvest$ent in > Co$!any 2'+'''
7o reverse the effect of !arent co$!any entries during the year for subsidiary dividends
and inco$e.
7he calculation of noncontrolling interest in 9llustration )21% is not affected by the
a$orti=ationOde!reciation of the differences between cost and book value. >ince the
differences between cost and book value re!resent a cost incurred by the !arent co$!any
in the !urchase of the subsidiary stock+ its de!reciationOa$orti=ation is charged in its
entirety to the !arent co$!any .controlling stockholders/ under current generally acce!ted
accounting !rinci!les .E66-/.
'ntries on #or&papers * +,,2 !.ear Subse/uent to Ac/uisition4
Fet+ a consolidated state$ents work!a!er under the co$!lete e"uity $ethod for
the year ended &ece$ber #1+ 2'')+ is !resented in 9llustration )21).
9F>E*7 illustration )21) here
:ork!a!er entries in 9llustration )21) are !resented in general journal for$ as follows:
DL1E >56&E
Co$!any ..3' 8,')+'''/ %3%+'''
..3' 81+)''+'''/ 1+2''+'''
9nvest$ent in > Co$!any 2+23%+'''

7o eli$inate invest$ent account against the e"uity accounts of > Co$!any using e"uity
balances at the beginning of the current year.
29
9/13/2001 02:48:00 PM
DL1E >56&E
.2/ 9nvest$ent in > Co$!any ,%+'''
Hadjust$ents fro$ !rior year for de!reciation
.82%+'''/ and COE> .8%'+'''/I

&e!reciation E!ense .82%'+'''O1' years/ 2%+'''
E"ui!$ent .net/ .82%'+''' 2 82%+'''
2 82%+'''/

142+'''
Land 12'+'''
Eoodwill 2''+'''
Kalue

,''+'''
DL1E >56&E
.2a/ 9nvest$ent in > Co$!any .re!laces COE> fro$ 2''%/ %'+'''
E"ui!$ent .net/ 2%'+'''
Land 12'+'''
Eoodwill 2''+'''
Entry .2a/ is identical to that recorded in the !receding year+ with the ece!tion that
the entry to Cost of Eoods >old is a!!ro!riate only in the year of ac"uisition.
Consolidated COE> .after the 8%'+''' adjust$ent/ will have been reflected in the 2''%
consolidated net inco$e and hence consolidated retained earnings at the end of 2''%. On
the books of - Co$!any+ the adjust$ent was reflected in e"uity in subsidiary inco$e in
2''% .and thus in ending retained earnings/ and in the invest$ent account. Decause the
invest$ent account $ust be eli$inated in the consolidating !rocess+ the entry to COE> is
re!laced here and in future years by an entry .8%'+''' debit/ to 9nvest$ent in > Co$!any.
7his co$!onent of the entry ca!tures one of the basic differences between the
Co$!lete E"uity $ethod and the other two $ethods. Only under the Co$!lete E"uity
$ethod does the !arents beginning retained earnings eactly $atch the a$ount re!orted
as consolidated retained earnings at the end of the !revious year. 5ence fewer work!a!er
adjust$ents to Deginning *etained Earnings2 - Co$!any are needed under the Co$!lete
E"uity $ethod. 7he 8%'+''' adjust$ent in year 2 .and future years/ related to inventory
valuation is $ade to 9nvest$ent in > Co$!any+ serving to facilitate the eli$ination of the
invest$ent account .by reversing an adjust$ent $ade by the !arent/.
DL1E >56&E
.2b/ &e!reciation E!ense .current year/ 2%+'''
9nvest$ent in > Co$!any .!rior year
de!reciation/
E"ui!$ent .net/
2%+'''
%3+'''
30
9/13/2001 02:48:00 PM
e"ui!$ent.
7his entry differs fro$ the first year in that the ecess de!reciation fro$ the year 2''%
is now reflected in a lowered balance in the 9nvest$ent account+ and this entry serves to
reverse that adjust$ent .again to facilitate eli$inating the 9nvest$ent account/. 6lthough
the adjust$ent to E"ui!$ent was already $ade in the !rior year work!a!er for one years
de!reciation adjust$ent+ it was not !osted to the books of > Co$!any and hence $ust be
$ade again. 9f the following year .2'',/ were being !resented+ the debit to &e!reciation
E!ense would re$ain at 2%+'''+ but the debit to 9nvest$ent in > Co$!any would be
%3+''' to reflect two !rior years of ecess de!reciation .and the credit to E"ui!$ent
would total 02+'''/. Clearly+ if entries .2a/ through .2b/ are recorded se!arately+ the
co$bined entry .2/ is not needed.
>56&E @O* :O*S-6-E* OFLP EF7*9E>
.#/ E"uity in >ubsidiary 9nco$e 33+'''
9nvest$ent in > Co$!any %'+'''
7o reverse the effect of !arent co$!any entries during the year 2'') for subsidiary
dividends and inco$e.
Observe that the consolidated balances in 9llustration )21) are the sa$e as those in
9llustration )20 .cost $ethod work!a!er/ and in 9llustration )211 .!artial e"uity
work!a!er/. @igure )2# !resents the entries in their se!arate co$!onents for all three
years side by side for the co$!lete e"uity $ethod.
CO2PLETE E9UIT" 2ET8OD ANAL"SIS OF CONTROLLIN7 INTEREST IN
CO2BINED NET INCO2E AND RETAINED EARNIN7S
:hen the !arent uses the co$!lete e"uity $ethod+ its re!orted inco$e e"uals
consolidated net inco$e. 6s with the other $ethods+ the a$ount of consolidated inco$e is
the parent company6s income from its independent operations plus 1minus4 its share of
adusted subsidiary income 1loss4 plus or minus adustments for the period relating to
the depreciation7amortization of the difference between mar&et and boo& value.
7he a$ount of consolidated net inco$e for the year ended &ece$ber #1+ 2'')+ is
8%)4+'''. Observe that this a$ount is re!orted both in the farthest left2hand colu$n of
9llustration )21) .- Co$!any inco$e/ and again in the farthest right2hand colu$n
.consolidated net inco$e/.
>i$ilarly+ the a$ount of consolidated retained earnings .82+110+'''/ at the end of
2'') is the sa$e as the ending retained earnings re!orted by - Co$!any. 6gain co$!are
the a$ount in the retained earnings section in the farthest left2hand colu$n of 9llustration
)21) .- Co$!any/ to the a$ount in the farthest right2hand colu$n .consolidated retained
earnings/. 7he a$ounts agree because - Co$!any recogni=es all adjust$ents in the
inco$e state$ent account ;e"uity in subsidiary inco$e< and thus in retained earnings.
ADDITIONAL CONSIDERATIONS RELATIN7 TO TREAT2ENT OF
DIFFERENCE BETWEEN COST AND BOOK VALUE
31
9/13/2001 02:48:00 PM
:e !resent additional considerations relating to the treat$ent of the difference
between cost and book value in the following sections. 7hese considerations include
allocation of the difference between cost and book value to liabilities and to assets with
fair values less than book valuesC the se!arate disclosure of accu$ulated de!reciationC
!re$ature dis!osals of long2lived assets by the subsidiaryC and de!reciable assets used in
$anufacturing.
A%%ocation o+ Di++e'ence !et$een Cost an Boo/ Va%ue to De!t
"d#ustment of $ontingent %iabilities and &eserves Often an ac"uiring fir$ reassesses the
ade"uacy of the ac"uired fir$s accounting for contingent liabilities+ !urchase
co$$it$ents+ reserves+ etc. !rior to its allocation of any difference between cost and book
values. 9f the accounting for these ite$s falls into a gray area of E66-+ the !urchaser $ay
decide to allocate so$e of the difference between cost and book value to adjust or create
liability accounts. @or ea$!le+ su!!ose that the !urchaser assesses a contingent liability
of the ac"uired fir$s to be both !robable and reasonably esti$able+ whereas the ac"uired
fir$ had !reviously disclosed it only in a note because it was dee$ed reasonably !ossible
.but not !robable/. Dy adjusting liabilities u!ward+ the difference to be allocated to assets
.and !otentially to goodwill/ is increased.
9nterestingly+ while $any fir$s have been critici=ed for $ani!ulating earnings to
avoid recording goodwill+ the :alt &isney Co$!any+ in its ac"uisition of Ca!ital
CitiesO6DC+ was accused by so$e sources of $anaging earnings via liabilities to record
excessive goodwill. 7he increase in recorded liabilities in such a case could be viewed as
!roviding a sort of cushion or $anage$ent tool for future earnings $ani!ulation.
In the News:
;5ow did &isneys accountants justify the creation of that huge reserve M justify adding
so$e 82.) billion in liabilities to its balance sheetT Es!ecially liabilities that+ %' days
before+ hadnt eisted on Ca! CitiesO6DCs balance sheetT Dasically+ by asserting that Ca!
CitiesO6DCs accounting had ignored the i$!act of ti$ing on antici!ated cash flows fro$
future !rogra$$ing that the network had agreed+ at least in !art+ to finance?7he reason
&isney went out on a li$b to create its undisclosed reserve is clear enough: fleibility. 9t
$eant that as its new television ar$ ran u! various !rogra$$ing costs after the $erger+
&isney had the o!tion of $erely writing those a$ounts off against those accrued liabilities
instead of running the$ through its inco$e state$ent M where they would have cri$!ed
re!orted !rofits.<
0
"llocation of 'ifference between $ost and (oo) *alue to %ong-Term 'ebt Fotes
!ayable+ long2ter$ debt+ and other obligations of an ac"uired co$!any should be valued
for consolidation !ur!oses at their fair values. Buoted $arket !rices+ if available+ are the
best evidence of the fair value of the debt. 9f "uoted $arket !rices are unavailable+ then
$anage$ents best esti$ate of the fair value $ay be based on fair values of debt with
si$ilar characteristics or on valuation techni"ues such as the !resent value of esti$ated
future cash flows.
3
7he !resent value should be deter$ined using a!!ro!riate $arket rates
of interest at the date of ac"uisition.
7
Barrons, 3/23/98, F%.ney?. Real Ma+%c,& #y A#ra(a )r%lo4, pp. 17,20.
32
9/13/2001 02:48:00 PM
6ssu$e+ for ea$!le+ that > Co$!any has outstanding 8)''+''' in ,(+ #'2year bonds
that were issued at !ar on January 1+ 1404+ and that interest on the bonds is !aid annually.
6ssu$e further that on January 1+ 2''%+ when - Co$!any ac"uires a 1''( interest in >
Co$!any+ the yield rate on bonds with si$ilar risk is 1'(. 7he !resent value of >
Co$!anyLs bonds !ayable deter$ined at the effective yield rate on the ac"uisition date for
five !eriods .the ti$e until $aturity/ is calculated as follows:
.1/ 9nterest -ay$ents 8#'+''' #.04'04 N 811#+02%
.2/ -rinci!al -ay$ent 8)''+''' .,2'42 N #1'+%,'
-resent Kalue of @uture Cash -ay$ents &iscounted at 1'( 8%2%+13%
.1/ 7he !resent value of an annuity of one for five !eriods discounted at 1'( is #.04'04.
.2/ 7he !resent value of an a$ount of one received five !eriods hence discounted at 1'(
is '.,2'42.
@ro$ the !oint of view of the consolidated entity+ bonds !ayable are overstated on
January 1+ 2''%+ by 80)+31, .8)''+''' 2 8%2%+13%/+ and a corres!onding a$ount of the
total difference between cost and book value on the date of ac"uisition $ust be allocated
to Uuna$orti=ed discount on bonds !ayable.U 9n years after ac"uisition+ interest e!ense
re!orted by the subsidiary will be understated for consolidation !ur!oses. 7hus+
work!a!er entries $ust be $ade to a$orti=e the discount in a $anner that will reflect
consolidated interest e!ense as a constant rate on the carrying value of the liability to the
consolidated entity. 6n a$orti=ation schedule for this !ur!ose is !resented in 9llustration
)21,. Consolidated state$ents work!a!er entries necessary in the first five years
subse"uent to - Co$!anyLs ac"uisition of > Co$!any are su$$ari=ed below.
Cost an Pa'tia% Equit& 2ethos
&ece$ber #1 2''% 2'') 2'', 2''0 2''3
&ebit Credit &ebit Credit &ebit Credit &ebit Credit &ebit Credit
1na$orti=ed &iscount
on Donds -ayable 0)+31, 0)+31, 0)+31, 0)+31,

0)+31,
&ifference Detween
Cost and Dook
Kalue 0)+31, 0)+31, 0)+31, 0)+31, 0)+31,
Deginning *etained
Earnings 2 - Co$!any
.Consolidated *etained
Earnings/

22'22 12+%13 2,+'03 %1+1'% )0+,##
9nterest E!ense 12+%13 1#+,,' 1)+'2, 1,+)24 13+13#
1na$orti=ed
&iscount on Donds
-ayable
12+%13 2,+'03 %1+1'% )0+,##

0)+31,
8
Financial Accounting Standards Board, ';-$ 98,1, .tate., ;! a pre.ent 1alue
tec(n%7ue %. u.ed, t(e e.t%ated !uture ca.( Go3. .(ould not %+nore rele1ant
pro1%.%on. o! t(e de#t a+reeent <!or e>aple, t(e r%+(t o! t(e %..uer to prepay=.&
33
9/13/2001 02:48:00 PM
Co-.%ete Equit& 2etho
&ece$ber #1 2''% 2'') 2'', 2''0 2''3
&ebit Credit &ebit Credit &ebit Credit &ebit Credit &ebit Credit
1na$orti=ed &iscount
on Donds -ayable 0)+31, 0)+31, 0)+31, 0)+31,

0)+31,
&ifference Detween
Cost and Dook
Kalue 0)+31, 0)+31, 0)+31, 0)+31, 0)+31,
9nvest$ent in >
Co$!any

22'22 12+%13 2,+'03 %1+1'% )0+,##
9nterest E!ense 12+%13 1#+,,' 1)+'2, 1,+)24 13+13#
1na$orti=ed
&iscount on Donds
-ayable
12+%13 2,+'03 %1+1'% )0+,##

0)+31,
6t $aturity the bonds will be redee$ed at !ar value .8)''+'''/+ which also will be the
carrying value to the consolidated entity. 9n all subse"uent years 80)+31, of the difference
between cost and book value will be debited to the beginning retained earnings of the
!arent co$!any in the consolidated state$ents work!a!er in order to reduce beginning
consolidated retained earnings for the cu$ulative a$ount of additional interest e!ense
recogni=ed in the consolidated financial state$ents in !rior years. 9f the co$!lete e"uity
$ethod is used+ the debit will be to the 9nvest$ent account+ as the !arent should have
already reflected the adjust$ent to earnings in its e"uity in subsidiary inco$e and hence in
its retained earnings.
9nsert illustration )21, here
7he !receding ea$!le was based on the assu$!tion that - Co$!any owned a
1''( interest in > Co$!any. 9f - Co$!any owned an 3'( interest rather than a 1''(
interest in > Co$!any+ the a$ount of the difference between cost and book value allocated
to una$orti=ed discount on bonds !ayable on the date of ac"uisition would be 8,'+,)#
H.3' .8)''+''' 2 8%2%+13%/I and the discount a$orti=ation would be 3'( of the
a$ounts shown in colu$n % of 9llustration )21,.
A%%ocatin( the Di++e'ence to Assets ?Lia!i%ities@ $ith Fai' Va%ues Less ?7'eate'@ Than
Boo/ Va%ues
>o$eti$es the fair value of an asset on the date of ac"uisition is less than the
a$ount recorded on the books of the subsidiary. 9n this case the allocation of the !arent
co$!anyLs share of the difference between the fair value and the book value of the asset
will result in a reduction of the asset. 9f the asset is de!reciable+ this difference will be
a$orti=ed over the life of the asset as a reduction of de!reciation e!ense. Likewise+ the
fair value of the long2ter$ debt $ay be greater rather than less than its recorded value on
the date of ac"uisition. 9n this case+ entries are necessary to allocate the !arent co$!anyLs
34
9/13/2001 02:48:00 PM
share of the difference between the fair value and book value of the debt to una$orti=ed
bond !re$iu$ and to a$orti=e it over the re$aining life of the debt as a reduction of
interest e!ense.
7o illustrate+ assu$e that - Co$!any !aid 82+2%'+''' for 3'( of the outstanding
stock of > Co$!any when > Co$!any had identifiable net assets with a fair value of
82+,''+''' and a book value of 82+1)'+'''. 7he fair values and book values of
identifiable assets and liabilities are !resented in 9llustration )210.
9nsert 9llustration )210
7he Co$!utation and 6llocation >chedule is !resented below.
Cost of 9nvest$ent .!urchase !rice/ 82+2%'+'''
.82+1)'+''' 3'(/ 1+02'+'''
&ifference between Cost and Dook Kalue )2'+'''
9ncrease securities ..3'81)'+'''/ .12'+'''/
&ecrease e"ui!$ent ..3'82)'+'''/+ % year life 2''+'''
9ncrease land ..3'8,0)+'''/ .)%'+'''/
9ncrease bonds !ayable ..3'812)+'''/ 1''+''' .#,'+'''/
Dalance .Ecess of Cost over @air Kalue/ 1,'+'''
*ecord Eoodwill .1,'+'''/
Dalance '
6ssu$e that the 81''+''' allocated to bond !re$iu$ is a$orti=ed over five years using
the straight2line $ethod+
4
and that the e"ui!$ent has a re$aining life of four years.
'nd of first year after ac/uisition 1wor&sheet entries4
6t the end of the first year the work!a!er entries are:
BLUE S8ADE
.1/ >ecurities 12'+'''
Land )%'+'''
Eoodwill 1,'+'''
E"ui!$ent .net/ 2''+'''
1na$orti=ed -re$iu$ on Donds -ayable 1''+'''
&ifference Detween Cost and Dook Kalue )2'+'''
7o allocate the difference between cost and book value on the date of ac"uisition
Fote that the assets accounts increased are recorded by debits and those decreased
by credits .E"ui!$ent/+ while a credit records an increase in a liability .increase in
1na$orti=ed -re$iu$ on Donds -ayable/.
.2/ E"ui!$ent .net/ )'+'''
9
7he straight2line $ethod is illustrated here as a $atter of e!ediency. :here differences between the
straight2line $ethod and the effective interest rate $ethod of a$orti=ation are $aterial+ the effective
interest rate $ethod as shown in 9llustration )21, should be used.
3B
9/13/2001 02:48:00 PM
&e!reciation e!ense )'+'''
7o adjust de!reciation e!ense downward .82''+'''O% years/.
.#/ 1na$orti=ed !re$iu$ on bonds !ayable 2'+'''
9nterest e!ense 2'+'''
7o a$orti=e !re$iu$ on bonds !ayable .81''+'''O) years/.
'nd of second year after ac/uisition 1wor&sheet entries4
6t the end of the second year the work!a!er entries are:
BLUE S8ADE
.1/ >ecurities 12'+'''
Land )%'+'''
Eoodwill 1,'+'''
E"ui!$ent .net/ 2''+'''
1na$orti=ed -re$iu$ on Donds -ayable 1''+'''
&ifference Detween Cost and Dook Kalue )2'+'''
7o allocate the difference between cost and book value on the date of ac"uisition .this
entry is re!eated in subse"uent years because the year of ac"uisition entry was recorded
only on a work!a!er/.
BLUE S8ADE
Cost and -artial E"uity Gethods Co$!lete E"uity Gethod
.2/ E"ui!$ent .net/ 1''+''
'
E"ui!$ent .net/ 1''+'''
Deginning *etained
Earnings M Co$!any -
)'+'''
9nvest$ent in >
Co$!any
)'+'''
&e!reciation e!ense
)'+'''
&e!reciation
e!ense
)'+'''
7o adjust de!reciation downward for the current and !rior year .82''+'''O% years/
Cost and -artial E"uity Gethods Co$!lete E"uity Gethod
.#/ 1na$orti=ed !re$iu$ on
bond !ayable
%'+'''
1na$orti=ed !re$iu$
on bond !ayable
%'+'''
Deginning *etained
Earnings M Co$!any -
2'+'''
9nvest$ent in >
Co$!any
2'+'''
9nterest e!ense
2'+'''
9nterest e!ense
2'+'''
7o a$orti=e !re$iu$ on bond !ayable for current and !rior year .81''+'''O) years/
9n the second year+ under the cost or !artial e"uity $ethod+ adjust$ents to the
beginning retained earnings of the !arent co$!any are necessary so that consolidated
retained earnings at the beginning of the second year will be e"ual to the consolidated
retained earnings re!orted at the end of the first year. 7he debits and credits are e"ual to
the adjust$ents to consolidated net inco$e that resulted fro$ the reduction of
de!reciation e!ense .8)'+'''/ and the reduction in interest e!ense .82'+'''/ in the
!rior yearLs work!a!er. 1nder the co$!lete e"uity $ethod+ no such adjust$ent to retained
earnings is needed since the !arents retained earnings reflects accurately the consolidated
3E
9/13/2001 02:48:00 PM
retained earnings each year. 9nstead entries are needed to the 9nvest$ent account to
facilitate the eli$ination of that account .by reversing the adjust$ents reflected therein/.
Re.o'tin( Accu-u%ate De.'eciation in Conso%iate Financia% State-ents as a
Se.a'ate Ba%ance
9n !revious illustrations we have assu$ed that any !articular classification of
de!reciable assets will be !resented in the consolidated financial state$ents as a single
balance net of accu$ulated de!reciation. :hen accu$ulated de!reciation is re!orted as a
se!arate balance in the consolidated financial state$ents+ the work!a!er entry to allocate
and de!reciate the difference between cost and book value $ust be slightly $odified. 7o
illustrate+ assu$e that - Co$!any ac"uires a 4'( interest in > Co$!any on January 1+
2''%+ and that the difference between cost and book value in the a$ount of 813'+''' is
entirely attributable to e"ui!$ent with an original life of nine years and a re$aining life on
January 1+ 2''%+ of si years. -ertinent infor$ation regarding the e"ui!$ent is !resented
in 9llustration )213.
9n 9llustration )213+ the 81+2''+''' fair value of the e"ui!$ent .gross/ is the
re!lace$ent cost of the e"ui!$ent if !urchased new and is referred to as replacement
cost new. 7he 8%''+''' in accu$ulated de!reciation in the fair value colu$n is the
!ro!ortional a$ount of re!lace$ent cost new necessary to bring the net fair $arket value
to 83''+'''+ which is the fair $arket value of the subsidiaryLs used e"ui!$ent. 7he
83''+''' fair value of the used e"ui!$ent is so$eti$es referred to in a!!raisal re!orts as
the e"ui!$entLs sound value.
9f the e"ui!$ent is to be !resented in the consolidated financial state$ents as one
balance net of accu$ulated de!reciation+ work!a!er eli$ination entries to allocate and
de!reciate the difference between cost and book value are si$ilar to those !resented in
9llustrations )2, and )20+ and are su$$ari=ed in 9llustration )214 for three years.
5owever+ when e"ui!$ent and accu$ulated de!reciation are re!orted as se!arate
balances in the consolidated financial state$ents+ the work!a!er eli$ination entries $ust
be $odified as !resented in 9llustration )22'. 7he a$ount debited to E"ui!$ent .Eross/
$inus the a$ount credited to 6ccu$ulated &e!reciation in each of the work!a!er entries
in 9llustration )22' is the sa$e as the a$ount debited to E"ui!$ent .net/ in the work!a!er
entries in 9llustration )214+ where e"ui!$ent is !resented in the consolidated financial
state$ents net of accu$ulated de!reciation.
9nsert illustrations )213+ )214+ )22'
7o allocate the 813'+''' difference assigned to Fet E"ui!$ent between E"ui!$ent
.Eross/ and 6ccu$ulated &e!reciation+ we need to know the re!lace$ent cost new and
the sound .used/ value of the e"ui!$ent as shown in the a!!raisal re!ort. 6lternatively+
these a$ounts $ay be inferred. 9f+ for ea$!le+ the e"ui!$ent is one2third de!reciated on
January 1+ 2''%+ the 813'+''' difference between - Co$!anyLs interest in the sound value
and the book value of the e"ui!$ent i$!lies that the difference can be ;grossed u!< by
dividing by 2O# as follows:
Let
6$ount of &ifference 6llocated to E"ui!$ent .Eross/ N Q
6$ount of &ifference 6llocated to 6ccu$ulated &e!reciation N .1O#/Q
37
9/13/2001 02:48:00 PM
7otal &ifference 6llocated to E"ui!$ent+ .Fet/ N .2O#/Q
Q M .1O#/Q N 13'+'''
.2O#/Q N 13'+'''
Q N 13'+''' .2O#/ N 820'+'''
.1O#/Q N .1O#/.20'+'''/ N 84'+'''
Dis.osa% o+ De.'ecia!%e Assets !& Su!siia'&
6ssu$e that on January 1+ 2'',+ two years after its ac"uisition by - Co$!any+ >
Co$!any sells all the e"ui!$ent referred to in 9llustration )213 for 8%3'+'''. On January
1+ 2'', .the date of the sale/+ the carrying value of the e"ui!$ent on the books of the
subsidiary is 8%''+''' but 8)2'+''' fro$ the consolidated !oint of view. 7hese values are
!resented in 9llustration )221. > Co$!any re!orts a gain of 83'+''' on the dis!osal of the
e"ui!$ent in its books.
:597E DOQ
S Co-.an&As Boo/s
Cash %3'+'''
6ccu$ulated de!reciation )''+'''
Eain on sale 3'+'''
E"ui!$ent 4''+'''
@ro$ the !oint of view of the consolidated entity+ however+ there is a loss of
8%'+'''. *ecall the usual work!a!er entry to allocate the difference between cost and
book value includes:
DL1E >56&E
E"ui!$ent 20'+'''
&ifference between cost and book value 13'+'''
6ccu$ulated de!reciation 4'+'''
7he work!a!er entry necessary to adjust the a$ounts in the &ece$ber #1+ 2'',+
consolidated financial state$ents is as follows .shown first for the cost or !artial e"uity
$ethods+ and second for the co$!lete e"uity $ethod/:
DL1E >56&E
Cost o' Pa'tia% Equit& 2etho
Deginning *etained Earnings 2 -arent Co$!any ,'+'''
.de!reciation e!ense adjust$ent for years 2''% and 2'')/
Eain on &is!osal of E"ui!$ent .eli$inates gain already recorded/ 3'+'''
Loss on &is!osal of E"ui!$ent .creates loss account/ %'+'''
&ifference Detween Cost and Dook Kalue 13'+'''
DL1E >56&E
Co-.%ete Equit& 2etho
38
9/13/2001 02:48:00 PM
9nvest$ent in > Co$!any ,'+'''
.de!reciation e!ense adjust$ent for years 2''% and 2'')/
Eain on &is!osal of E"ui!$ent .eli$inates gain already recorded/ 3'+'''
Loss on &is!osal of E"ui!$ent .creates loss account/ %'+'''
&ifference Detween Cost and Dook Kalue 13'+'''
9n the year of sale+ any gain or loss recogni=ed by the subsidiary on the dis!osal of
an asset to which any of the difference between cost and book value has been allocated
$ust be adjusted in the consolidated state$ents work!a!er. 7he entry above serves to
eli$inate the gain recorded by the subsidiary and record the correct loss .or gain/ to the
consolidated entity. 9t also debits beginning retained earnings M - Co$!any .or 9nvest$ent
in > Co$!any if the co$!lete e"uity $ethod is used/ to ;catch u!< the effects to the
consolidated entity of two !rior years of de!reciation e!ense.
De.'ecia!%e Assets Use in 2anu+actu'in(
:hen the difference between cost and book value is allocated to de!reciable assets
used in $anufacturing+ work!a!er entries necessary to reflect additional de!reciation $ay
be $ore co$!le+ because the current and !revious years additional de!reciation $ay
need to be allocated a$ong work in !rocess+ finished goods on hand at the end of the
year+ and cost of goods sold. 9n !ractice+ such refine$ents are often ignored on the basis
of $ateriality+ and all the current yearLs additional de!reciation is charged to cost of goods
sold.
(9S: ;$#< A))$9<=I<>
(ush down accounting is the establish$ent of a new accounting and re!orting basis
for a subsidiary co$!any in its se!arate financial state$ents based on the !urchase !rice
!aid by the !arent co$!any to ac"uire a controlling interest in the outstanding voting
stock of the subsidiary co$!any. 7his accounting $ethod is re"uired for the subsidiary in
so$e instances such as in the banking industry+ an industry overwhel$ed by the fre"uency
and etent of $erger activity in recent years.
-(e 1aluat%on %pl%ed #y t(e pr%ce o! t(e .toc2 to t(e parent
copany %. Hpu.(ed do3nH to t(e .u#.%d%ary and u.ed to re.tate %t.
a..et. <%nclud%n+ +ood3%ll= and l%a#%l%t%e. %n %t. .eparate 5nanc%al
.tateent.. ;! all t(e 1ot%n+ .toc2 %. purc(a.ed, t(e a..et. and
l%a#%l%t%e. o! t(e .u#.%d%ary copany are re.tated .o t(at t(e e>ce.. o!
t(e re.tated aount. o! t(e a..et. <%nclud%n+ +ood3%ll= o1er t(e
re.tated aount. o! t(e l%a#%l%t%e. e7ual. t(e purc(a.e pr%ce o! t(e
.toc2. Pu.( do3n account%n+ %. #a.ed on t(e not%on t(at t(e #a.%. o!
account%n+ !or purc(a.ed a..et. and l%a#%l%t%e. .(ould #e t(e .ae
re+ardle.. o! 3(et(er t(e ac7u%red copany cont%nue. to e>%.t a. a
.eparate .u#.%d%ary or %. er+ed %nto t(e parent copanyI.
operat%on.. -(u., under pu.( do3n account%n+, t(e parent copanyI.
co.t o! ac7u%r%n+ a .u#.%d%ary %. u.ed to e.ta#l%.( a ne3 account%n+
39
9/13/2001 02:48:00 PM
#a.%. !or t(e a..et. and l%a#%l%t%e. o! t(e .u#.%d%ary %n t(e .u#.%d%aryI.
.eparate 5nanc%al .tateent.. )ecau.e pu.( do3n account%n+ (a. not
#een addre..ed %n aut(or%tat%1e pronounceent. o! t(e $AS) or %t.
predece..or., pract%ce (a. #een %ncon.%.tent. Soe ac7u%red
copan%e. (a1e u.ed a ne3 pu.(ed do3n #a.%., and ot(er., %n
e..ent%ally t(e .ae c%rcu.tance., (a1e u.ed preac7u%.%t%on #oo2
1alue..
A'(u-ents Fo' an A(ainst Push Do$n Accountin(
-ro!onents of !ush down accounting believe that a new basis of accounting should be
re"uired following a !urchase transaction that results in a significant change in the
ownershi! of a co$!anyLs outstanding voting stock. 9n essence+ they view the transaction
as if the new owners had !urchased an eisting business and established a new co$!any to
continue that business. Conse"uently+ they believe that the !arent co$!anyLs basis should
be i$!uted to the subsidiary because the new basis !rovides $ore relevant infor$ation for
users of the subsidiaryLs se!arate financial state$ents. 9n addition+ "+( ,pinion No -.
re"uires that a business !urchased in a business co$bination be stated in consolidated
state$ents at the basis established in the !urchase transaction. 7o !rovide sy$$etry+ the
se!arate financial state$ents of the subsidiary should be !resented in the sa$e $anner.
7hose who o!!ose !ush down accounting believe that+ under the historical cost
conce!t+ a change in ownershi! of an entity does not justify a new accounting basis in its
financial state$ents. Decause the subsidiary did not !urchase assets or assu$e liabilities as
a result of the transaction+ the recognition of a new accounting basis based on a change in
ownershi!+ rather than on a transaction on the !art of the subsidiary+ re!resents a breach in
the historical cost conce!t in accounting. 7hey argue further that i$!le$entation !roble$s
$ight arise. @or ea$!le+ noncontrolling stockholders $ay not have $eaningful
co$!arative financial state$ents. 9n addition+ restate$ent of the financial state$ents $ay
create !roble$s in deter$ining or $aintaining co$!liance with various financial
restrictions under debt agree$ents.
-ush down accounting is an issue only if the subsidiary is re"uired to issue se!arate
financial state$ents for any reason+ for ea$!le+ because of the eistence of
noncontrolling interests or financial arrange$ents with nonaffiliates. 7hree i$!ortant
factors that should be considered in deter$ining the a!!ro!riateness of !ush down
accounting are:
1. :hether the subsidiary has outstanding debt held by the !ublic.
2. :hether the subsidiary has outstanding a senior class of ca!ital stock not ac"uired by
the !arent co$!any.
#. 7he level at which a $ajor change in ownershi! of an entity should be dee$ed to have
occurred+ for ea$!le+ 1''(+ 4'(+ )1(.
-ublic holders of the ac"uired co$!anyLs debt need co$!arative data to assess the
value and risk of their invest$ents. 7hese !ublic holders generally have so$e e!ressed
.or i$!lied/ rights in the subsidiary that $ay be adversely affected by a new basis of
accounting. >i$ilarly+ holders of !referred stock+ !articularly if the stock includes a
!artici!ation feature+ $ay have their rights altered significantly by a new basis of
accounting.
40
9/13/2001 02:48:00 PM
Kiews on the !ercentage level of ownershi! change needed to a!!ly a new basis of
accounting vary. >o$e believe that the !urchase of substantially all the voting stock .4'(
or $ore/ should be the threshold levelC others believe that the !ercentage level of
ownershi! change should be that needed for control+ that is+ $ore than )'(. 6 related
!roble$ involves the a$ounts to be allocated to the individual assets and liabilities+
noncontrolling interest+ and goodwill in the se!arate state$ents of the subsidiary. >o$e
believe that values should be allocated on the basis of the fair value of the subsidiary as a
whole i$!uted fro$ the transaction. 7hus+ if 3'( of the voting stock is ac"uired for 8#2
$illion+ the fair value of the net assets should be i$!uted to be 8%' $illion .8#2
$illionO.3'/+ and values allocated on that basis. Others believe that values would be
allocated on the basis of the !ro!ortional interest ac"uired. 7hey believe that new values
should be reflected on the books of the subsidiary only to the etent of the !rice !aid in
the transaction. 7hus+ if 3'( of a co$!any is ac"uired for 8#2 $illion+ the basis of the
subsidiaryLs net assets should be adjusted by the difference between the !rice !aid and the
book value of an 3'( interest. 7his latter a!!roach will result in the assign$ent of the
sa$e values to assets and liabilities on the books of the subsidiary as that !reviously
illustrated in the work!a!er entry to allocate the difference between cost and book value in
the consolidated state$ents work!a!er.
STATUS OF PUS8 DOWN ACCOUNTIN7
7he 7ask @orce on Consolidation -roble$s+ 6ccounting >tandards &ivision of the
69C-6+ released an issues !a!er entitled+ U-ush &own 6ccountingU in 1404. 7he !a!er
discussed the issues related to !ush down accounting and cited related literature. 7he
!a!er also !resented the conclusions of the 6ccounting >tandards Eecutive Co$$ittee
on the issues discussed in the !a!er. 7he $ajority of the Co$$ittee reco$$ended the use
of !ush down accounting where there had been at least a 4'( change in ownershi!.
9n 143#+ the >EC released Staff "ccounting (ulletin !S"(/ No 01+ which discusses
the staffLs !osition on the a!!ro!riateness of a!!lying !ush down accounting in the
se!arate financial state$ents of subsidiaries ac"uired in !urchase transactions. 7he >EC
believes that !urchase transactions that result in an entity beco$ing substantially wholly
owned .as defined in *egulation >2 Q/ should establish a new basis of accounting for the
!urchased assets and liabilities. :hen the for$ of ownershi! is within the control of the
!arent co$!any+ the basis of accounting for !urchased assets and liabilities should be the
sa$e regardless of whether the entity continues to eist or is $erged into the !arent
co$!anyLs o!erations. As a (ene'a% 'u%e= the SEC 'equi'es .ush o$n accountin(
$hen the o$ne'shi. chan(e is ('eate' than B5C an o!3ects to .ush o$n
accountin( $hen the o$ne'shi. chan(e is %ess than D<CE 9n addition+ the >EC staff in
S"( No 01 e!ress the view that the eistence of outstanding !ublic debt+ !referred
stock+ or a significant noncontrolling interest in a subsidiary $ight have i$!act on the
!arent co$!anyLs ability to control the for$ of ownershi!. 9n these circu$stances+ the staff
encourages+ but does not insist on+ the a!!lication of !ush down accounting.
9n &ece$ber 1441+ the @6>D issued a &iscussion Ge$orandu$ entitled "n
"nalysis of Issues &elated to New (asis "ccounting. 7he discussion $e$orandu$ was
!ublished to solicit views on which+ if any+ transactions or events should result in changing
the carrying a$ount of an entityLs individual assets+ including goodwill+ and liabilities to
a$ounts re!resenting their current fair values. 7ransactions and events discussed include
41
9/13/2001 02:48:00 PM
stock !urchases+ as well as significant borrowing transactions+ reorgani=ations and
restructurings+ and for$ations and sales of interests in joint ventures.
PUS8 DOWN ACCOUNTIN7 ILLUSTRATION
7o illustrate the a!!lication of !ush down accounting+ we use data !resented earlier in this
cha!ter+ with so$e $odifications+ as follows:
9nsert 9llustration )222 here.
1. - Co$!any ac"uired an 3'( interest in > Co$!any on January 1+ 2''% for
82+2''+'''+ at which ti$e > Co$!any had ca!ital stock of 81+)''+''' and retained
earnings of 8)''+'''.
2. 7he difference between cost and book value .8,''+'''/ is allocated as !resented in
9llustration )222.
9n this ea$!le+ we assu$e that values are allocated on the basis of the fair value of the
subsidiary as a whole+ i$!uted fro$ the transaction.
#. 9n 2''%+ > Co$!any re!orted net inco$e of 8#2+)''.
Fote that the net inco$e of > Co$!any .8#2+)''/ is 83'+''' less than the a$ount of
inco$e re!orted in 9llustration )2, because the effect of the de!reciation of the difference
between cost and book value is recorded on the books of > Co$!any under !ush down
accounting. 7his difference of 83'+''' consists of:
9ncrease in cost of goods sold 8)'+'''
9ncrease in de!reciation e!ense .8#''+'''O1' years/ #'+'''
83'+'''
%. > Co$!any declared a dividend of 82'+''' on Fove$ber 1)+ !ayable on &ece$ber 1+
2''%.
). - Co$!any uses the cost $ethod to record its invest$ent in > Co$!any.
S Co-.an& Boo/ Ent'ies 6 ;<<>
On January 1+ 2''%+ the date of ac"uisition+ > Co$!any would $ake the following entry
to record the effect of the !ushed down values i$!lied by the !urchase of 3'( of its stock
by - Co$!any:
9nventory+ 1O1 )'+'''
E"ui!$ent #''+'''
Land 1)'+'''
Eoodwill 2)'+'''
*evaluation Ca!ital 0)'+'''
42
9/13/2001 02:48:00 PM
6ssu$e the following: .1/ all beginning inventory was sold during the yearC and .2/
e"ui!$ent has a re$aining useful life of 1' years fro$ 1O1O2''%. Eiven these assu$!tions+
the 8)'+''' ecess cost allocated to beginning inventory would be included in cost of
goods sold when the goods were sold. >i$ilarly+ de!reciation e!ense recorded on >
Co$!anyLs books would be 8#'+''' greater than if the increase in e"ui!$ent value had
not been recorded.
6 work!a!er for the !re!aration of consolidated financial state$ents on &ece$ber #1+
2''%+ under !ush down accounting is !resented in 9llustration )22#. :ork!a!er
eli$ination entries in general journal for$ are:
DL1E >56&E
.1/ &ividend 9nco$e 1,+'''
&ividends &eclared 2 > Co$!any 1,+'''
.2/ Ca!ital >tock 2 > Co$!any 1+2''+'''
*etained Earnings 1O1 2 > Co$!any %''+'''
*evaluation Ca!ital 2 > Co$!any ,''+'''
9nsert illustration )22# here
6 co$!arison of 9llustration )22# with 9llustration )2, shows that co$bined inco$e is
s$aller+ as is the noncontrolling interest in co$bined inco$e when !ush down accounting
is used. Consolidated net inco$e and consolidated retained earnings are the sa$e. 7hus+
when values are assigned on the basis of fair values of the subsidiary as a whole i$!uted
fro$ the transaction+ the use of !ush down accounting has no effect on these consolidated
balances. Fote+ however+ that both consolidated net assets and the noncontrolling interest
in consolidated net assets are 81#%+''' greater in 9llustration )22#+ reflecting the decision
to !ush down the full value of > Co$!any i$!lied by the a$ount !aid by - Co$!any for
its 3'( interest. 7his a$ount can be verified as follows:
7he noncontrolling interestLs share of revaluation ca!ital
.2'.80)'+'''/

81)'+'''
Less: de!reciation thereon .2'.83'+'''/ 1,+'''
Dalance 81#%+'''
Fote also that no work!a!er entries were necessary in 9llustration )22# to allocate+ or
de!reciate the difference between cost and book value since these adjust$ents have
already been $ade on > Co$!anyLs books.
>1GG6*P
1. $alculate and allocate the difference between cost and boo) value to the subsidiary2s
assets and liabilities. -(e d%4erence #et3een t(e purc(a.e pr%ce and #oo2
1alue %. u.ed 5r.t to ad6u.t t(e %nd%1%dual a..et. and l%a#%l%t%e. to t(e%r
!a%r 1alue. on t(e date o! ac7u%.%t%on. ;! cost eceeds the aggregate fair values
of identifiable assets less liabilities+ the residual a$ount will be positive .a debit balance/. 6
43
9/13/2001 02:48:00 PM
!ositive residual difference is evidence of an uns!ecified intangible and is accounted for as
goodwill.
2. 3xplain how any excess of fair value over acquisition cost of net assets is allocated to
reduce the subsidiary2s assets and liabilities in the case of bargain purchases. :hen the
!urchase !rice .ac"uisition cost/ is below the aggregate fair value of identifiable assets less
liabilities+ the residual a$ount will be negative .a credit balance/. 6 negative residual
difference is evidence of a bargain !urchase+ with the difference between ac"uisition cost
and fair value designating the a$ount of the bargain. :hen a bargain ac"uisition occurs+
so$e of the ac"uired assets $ust be reduced below their fair values. >!ecifically+ long2
lived assets .other than invest$ents in $arketable securities/ are recorded at fair $arket
value $inus an adjust$ent for the bargain. 9f a bargain balance !ersists+ it is then
recogni=ed as an etraordinary gain in the !eriod of the ac"uisition.
#. 3xplain how goodwill is measured. Eoodwill is $easured as the ecess of !urchase
!rice over the fair value of the net assets ac"uired.
%. 'escribe how the allocation process differs if less than -445 of the subsidiary is
acquired. Consolidated net assets are written u! only by an a$ount e"ual to the .a'ent
co-.an&Fs sha'e of the difference on the date of ac"uisition between the i$!lied fair
value and the book value of the subsidiary co$!anyLs net assets .rather than the entire
difference between fair value and book value/.
). &ecord the entries needed on the parent2s boo)s to account for the investment under
the three methods: the cost6 the partial equity6 and the complete equity methods. 7he
$ost i$!ortant difference between the cost and e"uity $ethods !ertains to the !eriod in
which the !arent recogni=es subsidiary inco$e on its books. 9f the cost $ethod is in use+
the !arent recogni=es its share of subsidiary inco$e only when dividends are declared by
the subsidiary. 9f the !artial e"uity $ethod is in use+ the investor recogni=es its share of
the subsidiarys inco$e when re!orted by the subsidiary. 6 debit to cash and a credit to
the invest$ent account record the recei!t of dividends under the !artial e"uity $ethod.
7he co$!lete e"uity $ethod differs fro$ the !artial e"uity $ethod in that the share of
subsidiary inco$e recogni=ed by the !arent is adjusted fro$ the a$ount re!orted by the
subsidiary. >uch adjust$ents include the a$ount of ecess de!reciation i$!lied by the
difference between $arket values and book values of the underlying assets ac"uired.
,. +repare wor)papers for the year of acquisition and the year!s/ subsequent to the
acquisition6 assuming that the parent accounts for the investment using the cost6 the
partial equity6 and the complete equity methods. 1nder the cost $ethod+ dividends
declared by the subsidiary are eli$inated against dividend inco$e recorded by the !arent.
7he invest$ent account is eli$inated against the e"uity accounts of the subsidiary+ with
the difference between cost and book value recorded in a se!arate account by that na$e.
7he difference is then allocated to adjust underlying assets andOor liabilities+ and to record
goodwill in so$e cases. 6dditional entries are $ade to record ecess de!reciation on
assets written u! .or to decrease de!reciation if written down/. 1nder the e"uity $ethod+
the dividends declared by the subsidiary are eli$inated against the invest$ent account+ as
is the e"uity in subsidiary inco$e. 7he invest$ent account is eli$inated in the sa$e way
as under the cost $ethod. 9n subse"uent years+ the cost $ethod re"uires an initial entry to
establish reci!rocity or convert to e"uity. 7his entry+ which is not needed under the e"uity
44
9/13/2001 02:48:00 PM
$ethod+ debits the invest$ent account and credits retained earnings of the !arent .for the
change in retained earnings of the subsidiary fro$ the date of ac"uisition to the beginning
of the current year $ulti!lied by the !arents !ercentage/. Only under the co$!lete e"uity
$ethod does the !arents beginning retained earnings eactly $atch the a$ount re!orted
as consolidated retained earnings at the end of the !revious year. 5ence fewer work!a!er
adjust$ents to beginning retained earnings of the !arent are needed under the co$!lete
e"uity $ethod than under the two other $ethods.
0. 7nderstand the allocation of the difference between cost and boo) value to long-term
debt components. Fotes !ayable+ long2ter$ debt+ and other obligations of an ac"uired
co$!any should be valued for consolidation !ur!oses at their fair values. Buoted $arket
!rices+ if available+ are the best evidence of the fair value of the debt. 9f "uoted $arket
!rices are unavailable+ then $anage$ents best esti$ate of the fair value $ay be based on
fair values of debt with si$ilar characteristics or on valuation techni"ues such as the
!resent value of esti$ated future cash flows. 7he !resent value should be deter$ined
using a!!ro!riate $arket rates of interest at the date of ac"uisition.
3. 3xplain how to allocate the difference between cost and boo) value when some assets
have fair values below boo) values. 9n this case the allocation of the !arent co$!anyLs
share of the difference between the fair value and the book value of the asset will result in
a reduction of the asset. 9f the asset is de!reciable+ this difference will be a$orti=ed over
the life of the asset as a reduction of de!reciation e!ense.
4. 'istinguish between recording the subsidiary depreciable assets at net versus gross
fair values. :hen the assets are recorded net+ no accu$ulated de!reciation account is
used initially. :hen they are recorded gross+ an accu$ulated de!reciation account is
needed. 7o allocate the difference assigned to de!reciable assets between the asset
account .gross/ and the accu$ulated de!reciation account+ we $ust know the re!lace$ent
cost new and the sound .used/ value of the asset as shown in the a!!raisal re!ort.
6lternatively+ these a$ounts $ay be inferred.
1'. 7nderstand the concept of push down accounting. -ush down accounting is the
establish$ent of a new accounting and re!orting basis for a subsidiary co$!any in its
se!arate financial state$ents based on the !urchase !rice !aid by the !arent co$!any to
ac"uire a controlling interest in the outstanding voting stock of the subsidiary co$!any.
7his accounting $ethod is re"uired for the subsidiary in so$e instances+ usually when the
ownershi! level is over 4)( for !ublicly held co$!anies.
4B

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5 ALLOCATION AND DEPRECIATION OF DIFFERENCES BETWEEN COST

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