aaham2e ch 04 solutions final.doc

Ch. 4 solutions Advanced

CHAPTER 4

SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS

MULTIPLE CHOICE QUESTIONS

1.b

Goodwill at the date of acquisition is $10,000,000 ( = $16,000,000 4,000,000 + 8,000,000 10,000,000). Goodwill at 1/1/14 is $10,000,000 2,000,000 = $8,000,000.

Land, buildings and equipment revaluation at 1/1/14 is a credit of $8,000,000 [3 x (8,000,000/20)] = $(6,800,000).

Intangibles revaluation at 1/1/14 = $10,000,000 [3 x ($10,000,000/5)] = $4,000,000.

Eliminating entry R is as follows:

Goodwill8,000,000

Identifiable intangibles4,000,000

Land, buildings and equipment6,800,000

Investment in Salem5,200,000

2.bEliminating entry O is as follows:

Operating expenses2,100,000

Land, buildings and equipment400,000

Goodwill500,000


3.a

Calculation of Equity in Net Income:

Salems reported net income$ 2,500,000

Revaluation writeoffs:

Land, buildings and equipment depreciation400,000

Identifiable intangibles amortization(2,000,000)

Goodwill impairment loss(500,000)

Equity in income of Salem$ 400,000

4.c

Original cost$ 16,000,000

Change in Salems retained earnings to 1/1/1414,000,000

3 years land, buildings and equipment depreciation1,200,000

3 years identifiable intangibles amortization(6,000,000)

Goodwill impairment loss to 1/1/14(2,000,000)

Investment balance, 1/1/1423,200,000

Equity in net income, 2014400,000

Investment balance, 12/31/14$23,600,000

5.c

Customer listsBrand names

Book value > undiscounted cash flows?NoYes

Fair value$3,400,000

Book value5,200,000

Impairment loss--$1,800,000

6.d

Division 1Division 2

Step one: Division book value > fair value?YesYes

Step two:

Fair value of goodwill$1,000,000$8,000,000

Book value of goodwill1,600,0006,400,000

Impairment loss$ 600,000-0-

7.c

Division 1Division 2

Fair value of division$14,000,000$20,000,000

Book value of division16,000,00024,000,000

Potential goodwill impairment2,000,0004,000,000

Actual impairment loss$ 1,600,000$ 4,000,000

8.dCustomer listsBrand names

Fair value$1,200,000$3,400,000

Book value1,500,0005,200,000

Impairment loss$ 300,000$1,800,000

9.a

10.a

$500,000 100,000 = $400,000.

EXERCISES

E4.1Equity Method Accounting

Calculation of Equity in Net Income:

Johnsons reported net income$ 85,000,000


Plant assets $50,000,000/25(2,000,000)

Goodwill impairment loss(20,000,000)

Equity in net income of Johnson$ 63,000,000

Entries made by George during 2013:

Investment in Johnson500,000,000

Capital stock500,000,000

Investment in Johnson63,000,000

Equity in net income of Johnson63,000,000

Cash30,000,000

Investment in Johnson 30,000,000

E4.2Equity Method Income and Working Paper Eliminations

(all amounts in millions)a.Investment balance, 1/1/14

$2,286

Investment balance, 1/1/13 = $2,000 + $200

2,200

Change

86

2013 dividends

60

2013 equity income accrual

146

Writeoff of plant asset revaluation =($160/10)

16

Sabers 2013 net income

$ 162b.Sabers stockholders equity, 1/1/13

$2,000

2013 net income

162

2013 dividends

(60)

Sabers stockholders equity, 1/1/14

$2,102c.Sabers 2014 net income

$ 130

Extra depreciation on revalued plant assets

(16)

Equity income accrual

$ 114d. (C)

Equity income accrual114

Dividends Saber40

Investment in Saber74

(E)

Stockholders Equity Saber2,102

Investment in Saber2,102

(R)

Plant assets, net144

Goodwill40

Investment in Saber184

(O)

Depreciation expense16

Plant assets, net16

e.At the beginning of 2025, the plant assets are fully depreciated and the remaining balance for goodwill is $40 - $30 = $10.

(R)

Goodwill10

Investment in S10

Entry (O) is not needed since no revaluations are written off in 2025.

E4.3Consolidation at End of First Year

a. The acquisition entry is as follows:

Investment in Saddlestone10,300,000

Merger expenses250,000


Contingent consideration liability300,000

Cash250,000

Calculation of 2013 equity in net income:

Saddlestones reported net income$ 3,000,000

Revaluation writeoff:

Identifiable intangibles $2,000,000/5(400,000)

Equity in net income of Saddlestone$ 2,600,000

Peaks equity method entries for 2013:


Equity in net income of Saddlestone2,600,000

Cash1,000,000

Investment in Saddlestone 1,000,000

b.Calculation of goodwill is as follows:

Acquisition cost$ 10,300,000

Book value of Saddlestone(7,200,000)

Excess of acquisition cost over book value3,100,000

Identifiable intangibles(2,000,000)

Goodwill$ 1,100,000

Consolidation working paper eliminating entries for 2013:

(C)

Equity in net income of Saddlestone2,600,000

Dividends Saddlestone1,000,000


(E)

Stockholders equitySaddlestone, 1/17,200,000


E4.3continued(R)


Goodwill1,100,000


(O)

Amortization expense400,000

Identifiable intangibles400,000

E4.4Eliminating Entries after First and Second Years

a.Calculation of equity in net income for 2014:

Safecos reported net income$ 1,600,000


Equipment $500,000/5(100,000)

Inventory (200,000)

Goodwill impairment loss (50,000)

Equity in net income of Safeco$ 1,250,000

Peerlesss entries for 2014:

Investment in Safeco8,000,000

Cash8,000,000


Equity in net income of Safeco1,250,000

Cash600,000

Investment in Safeco 600,000

Calculation of goodwill is as follows:


Book value of Safeco(7,000,000)


Fair value less book value:

Equipment$ 500,000

Inventory200,000 (700,000)

Goodwill$ 300,000

E4.4continued


(C)


Dividends Safeco600,000

Investment in Safeco650,000

(E)

Stockholders equitySafeco, 1/17,000,000


(R)

Equipment, net500,000

Inventory200,000

Goodwill300,000


(O)

Depreciation expense100,000

Cost of goods sold200,000

Goodwill impairment loss50,000


Inventory200,000

Goodwill50,000

b. Calculation of equity in net income for 2015:

Safecos reported net income$ 2,000,000

Revaluation writeoff:

Equipment $500,000/5(100,000)

Equity in net income of Safeco$ 1,900,000

Peerlesss equity method entries for 2015:



Cash800,000


E4.4continued

The Investment in Safeco balance at December 31, 2015 is $8,000,000 + 1,250,000 600,000 + 1,900,000 800,000 = $9,750,000.


(C)


Dividends Safeco800,000


(E)

Stockholders equitySafeco, 1/18,000,000


Stockholders equitySafeco at 1/1/2015 = $7,000,000 + 1,600,000 600,000 = $8,000,000

(R)


Goodwill250,000


(O)



E4.5Equity Method, Eliminating Entries, Several Years after Acquisitiona. Calculation of total goodwill is as follows:Acquisition cost$ 6,000,000

Book value of Oslo(2,500,000)



Land$ 450,000

Buildings(400,000)


Long-term debt 250,000(1,300,000)

Goodwill$ 2,200,000

b.Calculation of Equity in net income for 2014:

Oslos reported net income$ 450,000


Buildings $(400,000)/2020,000

Long-term debt $250,000/10(25,000)


Equity in net income of Oslo$ 385,000

c.Calculation of Investment in Oslo, 12/31/14Investment in Oslo, 1/1/06$ 6,000,000

Oslos reported income, 2006-20134,000,000

Oslos reported dividends, 2006-2013(1,200,000)

Revaluation writeoffs, 2006-2013:

Buildings $[(400,000)/20] x 8160,000

Identifiable intangibles (full balance)(1,000,000)

Long-term debt $[250,000/10] x 8(200,000)

Goodwill impairment loss (300,000)

Investment in Oslo, 1/1/14 7,460,000


Oslos dividends, 2014 (100,000)

Investment in Oslo, 12/31/14$ 7,745,000

E4.5continuedd. Consolidation working paper eliminating entries for 2014:

(C)

Equity in net income of Oslo385,000

Dividends Oslo100,000

Investment in Oslo285,000

(E)

Stockholders equityOslo, 1/15,300,000

Investment in Oslo5,300,000

Stockholders equity, January 1, 2014 = $2,500,000 + 4,000,000 1,200,000 = $5,300,000.

(R)

Land450,000

Long-term debt50,000

Goodwill1,900,000

Investment in Oslo2,160,000

Buildings, net240,000

Revaluations at January 1, 2014 = original revaluations less writeoffs for 2006-2013.

(O)

Interest expense25,000



Long-term debt25,000


Goodwill60,000

E4.6Consolidation after Several Years

Calculation of total goodwill is as follows:


Book value of Baker(5,000,000)

Excess of acquisition cost over book value 2,500,000


Buildings(1,000,000)

Goodwill$ 1,500,000

Calculation of equity in net income for 2013:

Bakers reported net income$ 300,000


Buildings $1,000,000/25(40,000)


Equity in net income of Baker$ 160,000

Calculation of investment balance at December 31, 2013:

Investment in Baker, 12/31/06$ 7,500,000

Baker reported income, 2007-20121,300,000

Baker reported dividends, 2007-2012(400,000)


Buildings ($1,000,000/25) x 6(240,000)

Investment in Baker, 1/1/138,160,000


Dividends, 2013(100,000)

Investment in Baker, 12/31/13$ 8,220,000


(C)

Equity in net income of Baker160,000

Dividends Baker100,000

Investment in Baker60,000

(E)

Stockholders equityBaker, 1/15,900,000

Investment in Baker5,900,000

Stockholders equity, January 1, 2013 = $5,000,000 + 1,300,000 400,000 = $5,900,000.

E4.6continued

(R)


Goodwill1,500,000



(O)




Goodwill100,000

E4.7Goodwill Impairment Losses

a.Goodwill is not a standalone asset, but represents the value of above-average future performance potential that cannot be assigned to identifiable assets such as property or specific intangible assets. Because performance potential is related to business operations, to measure impairments in its value it must be connected with a specific business unit. In the case of Time Warner, as discussed in the text of Chapter 4, goodwill is assigned to Networks as a business unit. The WB Network was one part of this business unit, but did not comprise the entire unit.

b.First, Time Warner has the option to perform a qualitative analysis to determine if it is more likely than not that the business units book value exceeds its fair value. If so, the fair value of the business unit is calculated and compared with its book value. If book value exceeds fair value, we determine the amount of the impairment, if any, by comparing the fair value of the goodwill with its book value. An impairment loss is reported if book value exceeds fair value.

Since The WB Network was shut down, its future performance will no longer benefit Time Warner, and the impairment charge is appropriate. Had the qualitative assessment option been available in 2006, Time Warner would likely have bypassed this option due to strong indicators that The WB Networks future cash flows were significantly impaired.c.Time Warner has a 50% interest in The CW, so under U.S. GAAP it does not have a controlling interest and reports its investment using the equity method. Time Warners equity in the net income of The CW is reported as part of consolidated other income. The investment balance is reported as part of consolidated assets. The CWs individual assets, liabilities, revenues and expenses are not reported on the consolidated financial statements.

E4.8Projecting Consolidation Entries

a.

(R)

Land80,000


Investment in Samson98,000

Inventory has been sold, and the equipment revaluation as of the start of the third year is $30,000 (2 x 6,000) = $18,000.

(O)


Equipment, net6,000

b.(R)

Land80,000

Investment in Samson80,000

Inventory has been sold, and the equipment revaluation has been completely written off. Therefore no eliminating entry (O) is appropriate.

c.No eliminating entries are necessary to recognize or write off the revaluations, because the assets requiring revaluation have been either sold or written off.

E4.9Identifiable Intangibles and Goodwill, U.S. GAAP

Amortization expense for 2014:

Customer relationships$4,000,000/4$ 1,000,000

Favorable leaseholds$8,000,000/51,600,000

Total$2,600,000

Impairment testing identifiable intangibles:

Customer relationships

Book value = $4,000,000 2 x ($4,000,000/4) = $2,000,000

Book value > Sum of undiscounted cash flows? $2,000,000 > $1,200,000: Yes

Impairment loss = $2,000,000 - $900,000 = $1,100,000

Favorable leaseholds

Book value = $8,000,000 1.5 x ($8,000,000/5) = $5,600,000

Book value > Sum of undiscounted cash flows? $5,600,000 < $6,000,000: No

Brand names

Book value = $18,000,000

Book value > Sum of discounted cash flows? $18,000,000 > $7,000,000: Yes

Impairment loss = $18,000,000 - $7,000,000 = $11,000,000

Impairment testing Goodwill:

Reporting UnitUnit FV < BV?Fair Value of GWGW impairment loss

Asia$400,000,000 > $300,000,000: No

South America$350,000,000> $200,000,000: No

Europe$500,000,000< $600,000,000: Yes$500,000,000 385,000,000 = 115,000,000$250,000,000 115,000,000 = $135,000,000

Summary:

Amortization expense identifiable intangibles $ 2,600,000

Impairment losses identifiable intangibles

12,100,000

Goodwill impairment loss

135,000,000

Total

$149,700,000E4.10Identifiable Intangibles and Goodwill, IFRSAmortization expense for 2014:

Customer relationships$4,000,000/4$ 1,000,000

Favorable leaseholds$8,000,000/51,600,000

Total$2,600,000

Impairment testing identifiable intangibles:

Customer relationships

Book value = $4,000,000 2 x ($4,000,000/4) = $2,000,000

Book value > Sum of discounted cash flows? $2,000,000 > $900,000: Yes

Impairment loss = $2,000,000 - $900,000 = $1,100,000

Favorable leaseholds

Book value = $8,000,000 1.5 x ($8,000,000/5) = $5,600,000Book value > Sum of discounted cash flows? $5,600,000 > $4,400,000: Yes

Impairment loss = $5,600,000 $4,400,000 = $1,200,000

Brand names

Book value = $18,000,000

Book value > Sum of discounted cash flows? $18,000,000 > $7,000,000: Yes

Impairment loss = $18,000,000 - $7,000,000 = $11,000,000

Impairment testing Goodwill:

Reporting UnitUnit FV < BV?GW impairment loss

E. Asia$150,000,000 < $200,000,000: Yes$200,000,000 150,000 = $50,000,000; impairment limited to full goodwill balance of $40,000,000.

Indonesia$120,000,000 > $100,000,000: No

Brazil$140,000,000 >$130,000,000: No

Mediterranean$190,000,000 < $220,000,000: Yes$220,000,000 190,000,000 = $30,000,000

Scandinavia$230,000,000 < $300,000,000: Yes$300,000,000 230,000,000 = $70,000,000

Summary:

Amortization expense identifiable intangibles

$ 2,600,000

Impairment losses identifiable intangibles

13,300,000

Goodwill impairment loss

140,000,000

Total

$155,900,000E4.11Consolidated Income Statement

a.

(amounts in millions)

Sales $5,000 + 2,000$7,000

Cost of goods sold $3,000 + 800 + 1603,960

Gross margin3,040

Depreciation expense $500 + 140 (200/10) 620

Interest expense $100 + 60 + (100/5)180

Other expenses $600 + 7001,300

Total operating expenses2,100

Net income$ 940

b.Parson reports its own income of $800 million plus its equity in the income of Soaper of $140 million. Equity in the income of Soaper is Soapers reported income adjusted for write-offs of Soapers net asset revaluations. Consolidated income is Parsons and Soapers reported revenues and expenses, with Soapers expenses adjusted for the revaluation writeoffs. Parsons separately reported income and consolidated income therefore report the same items, packaged differently.

E4.12Amortization and Impairment Testing of Identifiable Intangible Assets

a.

Technology

Arroyo$15,000/5 x 9/12 =$ 2,250

WebEx$312,000/4 x 1/12 =6,500

Customer Relationships

Arroyo$14,000/7 x 9/12 =1,500

WebEx$153,000/6 x 1/12 =2,125

Total amortization expense$ 12,375

b.

Technology7/31/07

Book valueBook value> Undiscounted

cash flows?Impairment loss

Arroyo$ 12,750$12,750>$14,000? No----

WebEx305,500$305,500>$300,000? Yes$305,500-250,000 =$ 55,500

Customer Relationships

Arroyo12,500$12,500>$16,000? No----

WebEx150,875$150,875>$140,000? Yes$150,875-100,000 =50,875

Total impairment loss$106,375

c.

TechnologyCustomer Relationships

Arroyo$ 12,750$ 12,500

WebEx250,000100,000

7/31/07 book value$ 262,750$ 112,500

E4.13Consolidation Using Cost Method

Calculation of total goodwill is as follows:


Book value of Baker(5,000,000)

Excess of acquisition cost over book value 2,500,000


Buildings(1,000,000)

Goodwill$ 1,500,000

Calculation of adjustment to investment balance to convert it to complete equity method at January 1, 2013:

Baker reported income, 2007-2012$ 1,300,000

Baker reported dividends, 2007-2012(400,000)


Buildings ($1,000,000/25) x 6(240,000)

Adjustment to Investment in Baker, 1/1/13$ 660,000


(A)

Investment in Baker660,000

Stockholders equity Adam660,000

(C)

Dividend income Adam100,000

Dividends Baker100,000

(E)

Stockholders equityBaker, 1/15,900,000


Stockholders equity, January 1, 2013 = $5,000,000 + 1,300,000 400,000 = $5,900,000.

(R)


Goodwill1,500,000



(O)




Goodwill100,000

PROBLEMS

P4.1Condensed Consolidated Financial Statements One Year after Acquisition

a. Calculation of equity in net income for 2014:

Santos reported net income$ 5,000,000


Inventory (1) (2,000,000)

Plant assets $8,000,000/8(1,000,000)

Patents $1,500,000/4(375,000)

Long-term debt $1,000,000/10 100,000


Equity in net income of Santo$ 1,325,000

(1)Santos beginning inventory on its own books is $3,000,000 (= $5,200,000 + 4,000,000 6,200,000). Since Santos cost of goods sold is $4,000,000, its beginning inventory is completely sold in 2014, and the revaluation is written off.

b. Consolidation Working Paper, December 31, 2014

Trial Balances Taken From Books

Dr (Cr)Eliminations

PononSantoDrCrConsolidated

Balances

Cash and receivables$ 4,500,000$ 3,100,000$ 7,600,000

Inventory5,000,000 5,200,000(R) 2,000,0002,000,000 (O-1)10,200,000

Plant assets, net8,000,00012,000,000(R) 8,000,0001,000,000 (O-2)27,000,000

Investment in Santo26,325,000

--1,325,000 (C)

10,000,000 (E)

15,000,000 (R)--

Patents----(R) 1,500,000375,000 (O-3)1,125,000

Goodwill----(R) 4,500,000400,000 (O-5)4,100,000

Current liabilities(5,100,000)(2,000,000)(7,100,000)

Long-term debt(20,000,000)(3,300,000)(O-4) 100,0001,000,000 (R)(24,200,000)

Capital stock(8,000,000)(6,000,000)(E) 6,000,000(8,000,000)

Retained earnings, Jan. 1(4,800,000)(4,000,000)(E) 4,000,000(4,800,000)

Sales(30,000,000)(13,200,000)(43,200,000)

Equity in income of Santos(1,325,000)--(C) 1,325,000--

Cost of goods sold18,000,0004,000,000(O-1) 2,000,00024,000,000

Depreciation and amortization expense2,000,0003,200,000(O-2) 1,000,000

(O-3) 375,0006,575,000

Interest and other expenses5,400,0001,000,000100,000 (O-4)6,300,000

GW impairment loss -- --(O-5) 400,000 _______400,000

$ -0- $ -0-$ 31,200,000$31,200,000$ -0-

P4.1continued

c.

Consolidated Statement of Income and Retained Earnings For the Year 2014

Sales$ 43,200,000

Costs of goods sold(24,000,000)

Gross margin19,200,000

Operating expenses:

Depreciation and amortization expense$ 6,575,000

Interest and other expenses6,300,000

Goodwill impairment loss 400,000(13,275,000)

Net income5,925,000

Retained earnings, beginning balance 4,800,000

Retained earnings, ending balance$ 10,725,000

Consolidated Balance Sheet, December 31, 2014

Assets

Cash and receivables$ 7,600,000

Inventory10,200,000

Plant assets, net27,000,000

Patents1,125,000

Goodwill 4,100,000

Total assets$ 50,025,000

Liabilities and stockholders equity

Current liabilities$ 7,100,000

Long-term debt24,200,000


Retained earnings 10,725,000

Total liabilities and stockholders equity$ 50,025,000

P4.2Equity Method and Eliminating Entries Three Years after Acquisition


Sunset Coasts reported net income for 2014$ 200,000


Plant assets ($1,000,000)/10100,000

Identifiable intangibles $3,600,000/20(180,000)

Equity in net income of Sunset Coast$ 120,000

Note: Identifiable intangibles at the date of acquisition are $2,100,000 + 500,000 + 1,000,000 = $3,600,000.b. Calculation of investment balance at December 31, 2014:

Investment in Sunset Coast, December 31, 2011$ 3,500,000

Sunset Coasts reported income, 2012-2014850,000

Sunset Coasts reported dividends, 2012-2014 (50% of reported income)(425,000)


Plant assets [($1,000,000)/10] x 3300,000

Identifiable intangibles ($3,600,000/20) x 3 (540,000)


Note to instructor: Under LIFO and increasing inventory, the acquisition date revalued inventory is assumed to still be on hand.

c.Consolidation working paper eliminating entries for 2014:

(C)

Equity in net income of Sunset Coast120,000

Dividends Sunset Coast (.5 x $200,000)100,000

Investment in Sunset Coast20,000

P4.2continued(E)

Stockholders equitySunset Coast, 1/11,725,000

Investment in Sunset Coast1,725,000

Sunset Coasts stockholders equity, December 31, 2011 = $1,400,000 (acquisition cost $3,500,000 less excess over book value $2,100,000).

Sunset Coasts stockholders equity, January 1, 2014 = $1,400,000 + (1 - .5)(850,000 200,000) = $1,725,000.

(R)


Inventory500,000

Plant assets, net800,000


Revaluations at January 1, 2014 = original revaluations less writeoffs for 2012 and 2013.

(O)





d.Puffins income from its own operations plus equity in net income of Sunset Coast = consolidated net income: $600,000 + $120,000 = $720,000.

P4.3Consolidation at End of First Year, Preacquisition Contingency


Sanders reported net income for 2013$ 500,000


Inventory $80,000 x 60%(48,000)

Equipment $200,000/10 (20,000)

Equity in net income of Sanders$ 432,000

Perkinsentries for 2013:

Investment in Sanders4,000,000

Merger expenses50,000

Restructuring expenses100,000

Cash4,150,000

Investment in Sanders432,000

Equity in net income of Sanders432,000

Cash150,000

Investment in Sanders 150,000

b.Consolidation working paper eliminating entries for 2013:

(C)

Equity in net income of Sanders432,000

Dividends Sanders150,000

Investment in Sanders282,000

(E)

Stockholders equitySanders, 1/12,200,000


P4.3Consolidation at End of First Year, Preacquisition Contingency

(R)

Inventory80,000


In-process research and development300,000

Goodwill1,305,000

Lawsuit liability85,000


Note: Because the change in the lawsuit liability occurs within the measurement period, the increased liability value increases acquisition date goodwill.

(O)



Inventory48,000


P4.4Consolidated Balance Sheet Working Paper, Bargain Purchase (see related P3.4)

(all amounts in millions)

a.Calculation of equity in net income for 2013:

Saxons reported net income for 2013 ($10,000 + 10 8,000 40 25 1,600)$ 345


Inventory(100)

Marketable securities50

Buildings and equipment $300/20(15)

Long-term debt $110/5 (22)

Equity in net income of Saxon$ 258

Calculation of Investment balance, December 31, 2013:

Investment balance, December 31, 2012 (1)$2,000

Equity in net income for 2013258

Dividends for 2013 (100)

Investment balance, December 31, 2013$2,158

(1)Paxon acquired Saxon for $1,800, but there is a bargain gain that increases the investment balance by $200, as follows:

P4.4continued

Calculation of gain on acquisition:

Acquisition cost$ 1,800

Book value ($100 + 350 + 845)(1,295)

Excess of acquisition cost over book value 505

Excess of fair value over book value:

Inventory$ 100

Marketable securities(50)

Land245

Buildings and equipment300

Long-term debt (discount)110 705

Gain on acquisition$ 200

Therefore Paxons entry to record the acquisition was:

Investment in Saxon2,000

Cash1,800

Gain on acquisition200

b.

Consolidation Working Paper, December 31, 2013


Dr (Cr)Eliminations

PaxonSaxonDrCrConsolidated

Balances

Cash and receivables$ 3,100$ 800$ 3,900

Inventory2,260940(R) 100100 (O-1)3,200

Marketable securities----(O-2) 5050 (R)--

Investment in Saxon2,158--158 (C)

1,295 (E)

705 (R)--

Land650300(R) 2451,195

Buildings and equipment, net3,6001,150(R) 30015 (O-3)5,035

Current liabilities(2,020)(1,200)(3,220)

Long-term debt(5,000)(450)(R) 11022 (O-4)(5,362)

Common stock(500)(100)(E) 100(500)

Additional paid-in capital(1,200)(350)(E) 350(1,200)

Retained earnings, Jan. 1(2,610)(845)(E) 845(2,610)

Dividends500100100 (C)500

Sales revenue(30,000)(10,000)(40,000)

Equity in income of Saxon(258)--(C) 258--

Gain on sale of securities--(10)50 (O-2)(60)

Cost of goods sold26,0008,000(O-1) 10034,100

Depreciation expense30040(O-3) 15355

Interest expense25025(O-4) 22297

Other operating expenses2,7701,600______ _______4,370

$ -0-$ -0-$ 2,495 $ 2,495 $ -0-

P4.4continued

c.

Consolidated Statement of Income and Retained Earnings For the Year 2013

Sales$ 40,000

Costs of goods sold(34,100)

Gross margin 5,900

Operating expenses:

Depreciation expense$ 355

Interest expense297

Other operating expenses4,370(5,022)

Income before other gains 878

Gain on sale of securities 60

Net income 938

Retained earnings, January 12,610

Dividends (500)

Retained earnings, December 31$ 3,048

Consolidated Balance Sheet, December 31, 2013

Assets

Cash and receivables$ 3,900

Inventory3,200

Land1,195

Buildings and equipment, net 5,035

Total assets$ 13,330


Current liabilities$ 3,220

Long-term debt5,362

Common stock500

Additional paid-in capital1,200

Retained earnings 3,048

Total liabilities and stockholders equity$ 13,330

P4.5Goodwill Allocation and Impairment

a.Identifiable assets acquired$ 60,000,000

Liabilities assumed(25,000,000)

Net identifiable assets acquired 35,000,000

Total acquisition cost 75,000,000

Total goodwill$ 40,000,000

Allocation to business units:

Unit XUnit YUnit ZTotal

Identifiable assets acquired$ 32,000,000 $20,000,000 $ 8,000,000 $ 60,000,000

Liabilities assumed(18,000,000)(6,000,000)(1,000,000)(25,000,000)

Net assets assigned$ 14,000,000 $14,000,000$ 7,000,000 $ 35,000,000

Unit XUnit YUnit ZUnit J

Fair value of reporting unit$ 50,000,000 $ 30,000,000 $ 15,000,000

Less: Net assets assigned (14,000,000) (14,000,000) (7,000,000)

Increase in fair value__ N/A___ ___N/A___ ___N/A___ $20,000,000

Tentative allocation of goodwill 36,000,000 16,000,000 8,000,000 20,000,000

Total tentative allocation is $80,000,000; goodwill to be assigned is $40,000,000.

50% reduction(18,000,000)(8,000,000)(4,000,000)(10,000,000)

Allocation of goodwill$ 18,000,000 $ 8,000,000 $ 4,000,000 $10,000,000

P4.5continued

b.Step 1 of impairment test: Compare the fair value of each reporting unit at December 31, 2014 with its book value at that date.

Unit XUnit YUnit ZUnit J

Fair value at

December 31, 2014$30,000,000 $ 15,000,000$ 12,000,000$ 75,000,000

Book value at

December 31, 201434,000,00020,000,000 10,000,000 72,000,000

Difference$( 4,000,000)$(5,000,000)$2,000,000$(2,000,000)

Preliminary conclusionMay be impairedMay be impairedNot impairedNot impaired

Step 2 of the impairment test: For those reporting units where goodwill may be impaired, calculate the implied fair value of goodwill at December 31, 2014 and compare to the book value of goodwill at that date.

Unit XUnit Y

Fair value of reporting unit$ 30,000,000$ 15,000,000

Fair value of identifiable net assets at December 31, 201423,000,0006,000,000

Implied value of goodwill 7,000,000 9,000,000

Book value of goodwill18,000,0008,000,000

Difference$ (11,000,000)$ 1,000,000

ConclusionGoodwill is impairedGoodwill is not impaired

Goodwill is impaired for Reporting Unit X. An $11,000,000 goodwill impairment loss should be recorded at December 31, 2014.

P4.6Intangible Assets and Goodwill: Amortization and Impairment

2013 amortization expense:

Customer lists $500,000/5$ 100,000

Developed technology $800,000/1080,000

Total$ 180,000

2013 impairment test for identifiable intangibles:

Customer listsDeveloped technologyInternet domain name

Original book value$ 500,000 $ 800,000 $ 1,300,000

Less: amortization

2011(100,000)(80,000)

2012(100,000)(80,000)

2013 (100,000) (80,000)________

Book value, December 31, 2013$ 200,000$ 560,000$ 1,300,000

Step 1 of impairment test: To determine whether impairment has occurred, compare the undiscounted future cash flows from the asset to its book value.

Customer listsDeveloped technologyInternet domain name

Future undiscounted cash flows$ 250,000$ 500,000 $ 1,000,000

Book value200,000560,000 1,300,000

Difference$ 50,000$ (60,000)$ (300,000)

ConclusionNot impairedImpairedImpaired

Step 2 of impairment test: For intangibles that are deemed impaired in Step 1, calculate amount of impairment as the difference between discounted cash flows and book value.

Developed technologyInternet domain name

Future discounted cash flows$ 420,000$ 750,000

Book value560,0001,300,000

Impairment$ 140,000$ 550,000

P4.6continued

2013 goodwill impairment test:

Step 1 of impairment test: compare fair value of reporting unit at December 31, 2013 to the book value of the unit at that date.

Fair value of reporting unit$17,000,000

Book value18,500,000

Difference$(1,500,000)

Conclusion: Goodwill may be impaired.

Step 2 of impairment test: Calculate the implied fair value of goodwill at December 31, 2013 and compare to the book value at that date.

Fair value of reporting unit$ 17,000,000

Fair value of identifiable net assets 14,200,000

Implied fair value of goodwill2,800,000

Book value of goodwill 6,200,000

Difference$ (3,400,000)

Conclusion: Goodwill impairment loss is $3,400,000.

Summary:

Amortization expense for 2013:

Customer lists$ 100,000

Developed technology 80,000$ 180,000

Impairment write-offs for 2013:

Developed technology$ 140,000

Internet domain name550,000

Goodwill3,400,000 4,090,000

Total expense for 2013$ 4,270,000

P4.7Consolidated Balance Sheet Working Paper, Three Years after Acquisition (see related P3.2)

(all amounts in millions)

a. Calculation of equity in net income for fiscal 2011, 2012, and 2013:

201120122013

GOCs reported net income (loss)$ 15$ (2)$ 12 (1)


Property, plant and equipment $(60)/2033 3

Patents and trademarks $10/5(2)(2) (2)

Long-term debt $(3)/311 1

Advanced technology $5/5(1)(1) (1)

Customer lists impairment loss(2) (4)

Goodwill impairment loss_(2)_(3) _(2)

Equity in net income of GOC$ 14$ (6) $ 7

(1) $12 = $900 800 88

Calculation of Investment balance, June 30, 2013:

Investment balance, June 30, 2010 (adjusted to remove earnings contingency)$ 110

Equity in net income for fiscal 201114

Equity in net income for fiscal 2012(6)

Equity in net income for fiscal 20137

Increase in GOCs AOCI for fiscal 2011-2013 (= $5 3)__2

Investment balance, June 30, 2013$ 127

P4.7continuedb.

Consolidation Working Paper, June 30, 2013


Dr. (Cr.)Eliminations

ITIGOCDrCrConsolidated

Balances

Current assets$ 232$ 12(R) 5$ 249

Property, plant and equipment, net600140(O-1) 354 (R)689

Identifiable intangible assets1,10030(R) 6

(R) 3

(R) 232 (O-2)

1 (O-4)

4 (O-5)1,155

Investment in GOC127--7 (C)

55 (E)

65 (R)--

Goodwill (1)----(R) 832 (O-6)81

Current liabilities(175)(10)(185)

Long-term liabilities(1,125)(105)(O-3) 11 (R)(1,230)

Common stock(22)(4)(E) 4(22)

Additional paid-in capital(580)(60)(E) 60(580)

Retained earnings, July 1(118)1212 (E)(118)

Accumulated other comprehensive income(20)(5)(E) 5(20)

Treasury stock822 (E)8

Sales revenue(2,000)(900)(2,900)

Equity in income of Saxon(7)--(C) 7--

Cost of goods sold1,4008002,200

Goodwill impairment loss ----(O-6) 2 2

Other operating expenses580

_____88

_____(O-2) 2

(O-4) 1

(O-5) 4 3 (O-1)

1 (O-3)

___________671

$ -0- $ -0- $ 209$ 209$ -0-

(1)Acquisition-date goodwill is calculated as follows:

Acquisition cost (adjusted)$ 110

GOCs book value(40)

Excess of acquisition cost over book value70

Excess of fair value over book value:

Inventory$ 5

Property, plant and equipment(60)

Patents and trademarks10

Advanced technology5

Customer lists25

Long-term debt(3)_(18)

Goodwill$ 88

P4.7continued

c.

Consolidated Statement of Income and Retained Earnings For Fiscal 2013

Sales revenue$ 2,900

Costs of goods sold(2,200)

Gross margin700

Operating expenses:

Goodwill impairment loss$ 2

Other operating expenses_671__673

Net income27

Retained earnings, beginning balance__118

Retained earnings, ending balance$ 145

Consolidated Balance Sheet, June 30, 2013

Assets

Current assets$ 249

Property, plant and equipment, net689

Identifiable intangible assets1,155

Goodwill__81

Total assets$ 2,174


Current liabilities$ 185

Long-term liabilities1,230

Common stock22

Additional paid-in capital580

Retained earnings145

Accumulated other comprehensive income20

Treasury stock__(8)

Total liabilities and stockholders equity$ 2,174

P4.8Working Paper Eliminating Entries, Partial Year Consolidation (see related P3.3)

(all numbers in millions)

a.Calculation of Equity in net income for 2003:

Pharmacias reported net income$ 5,000


Inventory(2,939)

Property, plant and equipment [$(317)/20] x [8.5/12]11

In-process research and development(716)

Developed technology rights $31,596/11 x (8.5/12)(2,035)

Long-term debt12

Other assets $(15,606)/10 x (8.5/12)1,105

Equity in net income of Pharmacia$ 438

b.Consolidation working paper eliminating entries for 2003:

(C)

Equity in net income of Pharmacia438

Investment in Pharmacia438

(E)

Stockholders equityPharmacia, 4/16/037,236

Investment in Pharmacia7,236

(R)

Inventory2,939

Long-term investments40

In-process R&D5,052

Developed technology rights37,066

Goodwill21,304

Property, plant and equipment317

Long-term debt1,841

Other assets15,606

Investment in Pharmacia48,637

P4.8continued

(O)


Property, plant and equipment11

Impairment loss 716


Long-term debt12

Other assets1,105

Inventory2,939

Depreciation expense11

In-process research and development716

Developed technology rights2,035

Interest expense12

Other operating expenses1,105

P4.9Goodwill Impairment Testing, IFRS and U.S. GAAP

a.BPs 2010 annual report states the following:

The future cash flows are adjusted for risks specific to the cash-generating unit and are discounted using a pre-tax discount rate. The discount rate is derived from the groups post-tax weighted average cost of capital and is adjusted where applicable to take into account any specific risk relating to the country where the cash-generating unit is located.

Cash flows are adjusted for specific risks and the applicable tax effects before they are discounted, thereby taking into consideration differences in the uncertainty of the business environment. Most likely the cash flows of Exploration and Production segment CGUs are more uncertain than those of Refining and Marketing, although the two segments are closely related.

If the cash flows were not adjusted, the discount rate should be adjusted to reflect differences in risk.P4.9continued

b.Exploration and ProductionCGUValue in useBook valueImpairment loss

UK$ 9,000$ 1,114None

US35,0006,144None

Rest of world2,5002,840$ 340

Total$ 46,500$ 10,098

Refining and Marketing

CGUValue in useBook valueImpairment loss

Rhine FVC$ 13,000$ 1,557None

Lubricants6,0001,938None

Other4,0004,880$ 880

Total$ 23,000$ 8,375

Total goodwill impairment loss is $340 + 880 = $1,220

c.$2,840 2,140 = $700, suggesting a GW impairment loss of that amount. However, total goodwill allocated to the Rest of World CGU is $630. Therefore, the goodwill impairment loss is $630, and other assets of the CGU would be written down, based on appropriate impairment tests.

d.U.S. GAAP requires goodwill to be assigned to reporting units, in this case Exploration and Production, and Refining and Marketing. When testing for impairment, BP has the option to perform a qualitative assessment of each reporting unit, using economic, financial, and strategic factors, to determine if it is more likely than not that the units book value exceeds its fair value. If so, the reporting units goodwill is evaluated using a two-step test. Goodwill is tested for impairment only if the estimated fair value of the reporting unit is in fact less than its book value. Because fair value is generally calculated using discounted cash flows, we assume it can be approximated by value-in-use. For both reporting units above, value in use significantly exceeds book value, so no impairment loss is reported, whether BP uses or bypasses the qualitative test.

Because reporting units aggregate CGUs, it is likely that CGUs with book value greater than value in use will be offset by those with a value in use that is greater than book value when applying the first step for impairment testing under U.S. GAAP.

P4.10Consolidation One and Two Years after Acquisition

a.The investment cost amounts to $598,000,000 [= ($590,000,000 $15,000,000) + $23,000,000], and the $248,000,000 excess of acquisition cost over book value ($598,000,000 $350,000,000) is allocated as follows, with goodwill being the residual at the bottom:

Excess of acquisition cost over book value$ 248,000,000

Allocation to identifiable items:

Inventories(30,000,000)

Identifiable intangibles (5-year life)(40,000,000)

In-process research and development (IPRD)(60,000,000)

Plant assets (20-year life, straight-line) (50,000,000)

Goodwill (unallocated balance)$ 68,000,000

b.2007 equity income accrual:

Essexs reported net income$ 140,000,000

Revaluation write-offs:

FIFO inventory sold (.4 X $30,000,000)(12,000,000)

Amortization of identifiable intangibles ($40,000,000/5)(8,000,000)

Depreciation of plant assets ($50,000,000/20)(2,500,000)

Goodwill impairment(15,000,000)

Equity income accrual$ 102,500,000

December 31, 2007 working paper eliminations:

(C)

Equity income accrual102,500,000

Dividends Essex (.55 x $140,000,000)77,000,000

Investment in Essex25,500,000

(E)

Stockholders equity Essex, 1/25/07350,000,000


P4.10continued

(R)

Inventories 30,000,000


In-process research and development60,000,000

Plant assets50,000,000

Goodwill 68,000,000


(O)

Cost of goods sold12,000,000

Amortization expense8,000,000

Depreciation expense2,500,000

Goodwill impairment loss15,000,000

Inventories12,000,000


Accumulated depreciation2,500,000

Goodwill15,000,000

c. 2008 equity income accrual:

Essexs reported net income$160,000,000

Revaluation write-offs:

Amortization of identifiable intangibles ($40,000,000/5)(8,000,000)

Depreciation of plant assets ($50,000,000/20)(2,500,000)

IPRD impairment (20,000,000)

Equity income accrual$129,500,000

December 31, 2008, working paper eliminations:

(C)

Equity income accrual129,500,000

Dividends Essex (.55 x $160,000,000)88,000,000


P4.10continued

(E)

Stockholders equity Essex, 1/1/08 (1)413,000,000


(1)$350,000,000 + $140,000,000 - $77,000,000

(R)

Inventories (.6 x $30,000,000)18,000,000


In-process research and development60,000,000

Plant assets50,000,000

Goodwill 53,000,000

Accum. depreciation2,500,000


(O)

Amortization expense8,000,000

Depreciation expense2,500,000

IPRD impairment loss20,000,000


Accumulated depreciation2,500,000

IPRD20,000,000

P4.11Intangibles under IFRS

a. Whereas the double-declining balance rate is twice the straight-line rate, 150% declining balance is 1.5 x 10% straight-line rate, or 15%. Following the conventional declining-balance calculations, we have this amount of amortization expense for 2013, the second year after acquisition:

Amortization expense = .15 x [200 million (.15 x 200 million)] = 25.5 millionb. At December 31, 2012, the book value is 36 million after 2012 amortization of 4 million, and the market value of these intangibles is 45 million.

December 31, 2012 entries are (all amounts in millions):

Amortization expense

4

Intangible assets4

Intangible assets

9

Revaluation surplus (OCI)9

December 31, 2013, entries are:

Amortization expense5

Intangible assets5

45 million/9 = 5 millionRevaluation surplus (OCI)9

Loss (income)1

Intangible assets10

At this point the ending book value is 30 million (= 40 4 + 9 5 10], equal to the market value on that date.

c. IFRS impairment loss = book value greater of (value-in-use, 1,800 million; market value, 1,500 million) = 2,000 1,800 = 200 million.

U.S. GAAP impairment loss = 0 (sum of undiscounted cash flows 2,500 million > book value, 2,000 million, indicating no impairment).

The two-step test in U.S GAAP removes some potential impairments from consideration because of the book value: undiscounted cash flows screen. IFRS directly compares fair value (market value or value-in-use, whichever is higher) with book value. Since fair value is lower than the sum of the undiscounted cash flows, IFRS will likely recognize more impairment losses over time than U.S. GAAP. P4.12Consolidation in First Year, Intangible Asset Issues

(all dollar amounts in millions)

a. Net Assets = Assets - Liabilities

$26,900 = $(20,800 + 9,400 + 4,800) Liabilities

Liabilities = $35,000 $26,900

Liabilities = $8,100

b. Going by the book, the question is simply whether useful lives can be reasonably estimated or whether the intangible has an obviously very long indeterminate (indefinite) life. Many cases will be clear-cut and can be justified to the auditors but others will be in gray areas such that the desired reporting result will call forth the case justifying the classification of the intangible one way or another.

In these gray areas, management may elect to minimize periodic amortization charges against earnings and take their chances on the somewhat random and very subjective impairment tests. To the extent possible, management would likely classify items and load cost in the indefinite-lived category to minimize the effect on earnings.

c. With impairment charges being part of income from continuing operations, companies may seek to lower the probability that they will have to recognize goodwill impairment charges. The subjectivity inherent in valuing the reporting units to which the goodwill is assignedcash flow forecasts and discount rate selectionsfacilitates decisions to load goodwill onto reporting units that are less-likely impairment candidates, i.e., units with fair value significantly above book value.

d. Revaluation of limited-life intangibles is $2,000 (= $3,000 $1,000).

Amortization of this revaluation for 2007 = $2,000/15 x 9/12 = $100.

Equity method income = $1,000 $100 = $900

Consolidation working paper entries:

(C)

Equity income

900

DividendsCaremark550

Investment in Caremark350

(E)

Stockholders equityCaremark (1)1,700

Investment in Caremark1,700

(1)$26,900 $20,800 ($9,400 $5,000)

P4.12continued

(R)

Goodwill20,800

Identifiable intangibles, limited life 2,000

Identifiable intangibles, indefinite life (2)2,400

Investment in Caremark25,200

(2)$6,400 $4,000

(O)

Amortization expense100

Identifiable intangibles, limited life100

P4.13Cost Method and Eliminating Entries Three Years after Acquisition

Calculation of Investment balance at January 1, 2014:


Sunset Coasts reported income, 2012-2013650,000

Sunset Coasts reported dividends, 2012-2013 (50% of reported income)(325,000)


Plant assets [($1,000,000)/10] x 2200,000

Identifiable intangibles ($3,600,000/20) x 2 (360,000)

Investment in Sunset Coast, January 1, 2014$ 3,665,000

Note to instructor: Under LIFO and increasing inventory, the acquisition date revalued inventory is assumed to still be on hand.


(A)


Stockholders equityPuffin, 1/1 3,665,000

(C)

Dividend income100,000

Dividends Sunset Coast (.5 x $200,000)100,000

P4.13Cost Method and Eliminating Entries Three Years after Acquisition

(E)

Stockholders equitySunset Coast, 1/11,725,000


Sunset Coasts stockholders equity, December 31, 2011 = $1,400,000 (acquisition cost $3,500,000 less excess over book value $2,100,000).

Sunset Coasts stockholders equity, January 1, 2014 = $1,400,000 + (1 - .5)(850,000 200,000) = $1,725,000.

(R)


Inventory500,000



Revaluations at January 1, 2014 = original revaluations less writeoffs for 2012 and 2013.

(O)





Cambridge Business Publishers, 2013

44

Advanced Accounting, 2nd EditionCambridge Business Publishers, 2013

Solutions Manual, Chapter 41

aaham2e ch 04 solutions final.doc

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