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ADV_SP08_MAR_17 - Olin Business School ACCOUNTING 4680 563...

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Olin Business School ACCOUNTING 4680 / 563 - SPRING 2008 ADVANCED ACCOUNTING LECTURE OUTLINE - March 17, 2008 THE CONSOLIDATION PROCESS (after acquisition) DIFFERENTIAL RELATED TO DISPOSED ASSETS Whenever an unamortized component of the differential relates to an asset that has been disposed or a liability that has been retired, an “eliminating entry” is made in the year of the disposal / liability to amortize the remaining component of the differential. This entry will have the effect of increasing / decreasing any gain / loss recorded on the disposal (retirement) of the asset (liability). EX . Parent purchases 75% of Sub, Inc. at a time when the book value of Sub’s PP&E is $ 1,200,000 and the fair value of Sub’s PP&E is $ 1,600,000. At the time of the acquisition, Sub’s PP&E was expected to last 10 more years, at which point the salvage was expected to be $0. Three years after the acquisition, Sub sold all of the PP&E for $ 950,000, and prepared the following entry to record the sale: Cash $ 950,000 PP&E (net) $ 840,000 [1] Gain on Sale of PP&E 110,000 [1] Equal to $1,200,000 less three years of depreciation at $120,000 per year. Q . What “eliminating entry” should be made to amortize the unamortized differential relating to the PP&E? A . Gain on Sale of PP&E $ 210,000 PP&E $ 210,000 This entry eliminates the unamortized component of the differential relating the PP&E. The net impact is that on 1
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the consolidated income statement the sale of the PP&E will result in a loss (i.e. negative gain) in the amount of $ 100,000. (Another way to calculate this loss is to note that at the time of acquisition, the consolidated balance sheet reports the PP&E at $1,500,000 { equal to $ 1,200,000 + .75 x ($1,600,000 - $ 1,200,000) }. After three years of depreciation, the consolidated carrying value would be $ 1,050,000, and thus if the PP&E were sold for $ 950,000 the consolidated entity would report a loss of $ 100,000.) DIFFERENTIAL RELATED TO BONDS PAYABLE The fair value of an acquired company’s bonds will differ from their carrying value if the market rate at the time of acquisition differs from the market rate at the time the bonds were issued. An implication of such a difference is that part of the purchase differential will be assigned to (a Discount or Premium on) Bonds Payable. In subsequent accounting periods an “elimination entry” must be made so that consolidated interest expense reflects the fair value of the bonds at the time the subsidiary was acquired. EX . On January 1, 2005, Short-Time Inc. issued $1,000,000 of 6 % coupon, eight-year bonds, with interest being paid once per year. At the time of the issue, the market rate for similar bonds was 9%. Accordingly, the bonds initially sold for $ 833,955 (equal to $ 60,000 x PVA 8, 9% + 1,000,000 x PVF 8, 9% ), and Short-Time prepared the following amortization schedule: CASH INTEREST DISCOUNT CARRYING DATE PAID EXPENSE AMORTIZED VALUE 833,955 12/31/05 60,000 75,056 15,056 849,011 12/31/06 60,000 76,411 16,411 865,422 12/31/07 60,000 77,888 17,888 883,310 12/31/08 60,000 79,498 19,498 902,808 12/31/09 60,000 81,253 21,253 924,061 12/31/10 60,000 83,166 23,166 947,227 12/31/11 60,000 85,250 25,250 972,477 12/31/12 60,000 87,523 27,523 1,000,000 480,000 646,045 166,045 2
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On January 1, 2008, Big Time Corp. acquired Short-Time, Inc. At the time of acquisition, the market rate for equivalent bonds was 7%. Accordingly, the fair value of these bonds at the time of acquisition was $ 958,998 (equal to $ 60,000 x PVA 5,7%
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