5

ALLOCATION AND DEPRECIATION OF

DIFFERENCES BETWEEN IMPLIED AND
BOOK VALUES (ONLINE)

5.10 PUSH DOWN ACCOUNTING

LO 10 Push down of accounting to the Push down accounting is the establishment of a new accounting and reporting basis for
subsidiary’s books. a subsidiary company in its separate financial statements based on the purchase price
paid by the parent company to acquire a controlling interest in the outstanding voting
stock of the subsidiary company. This accounting method is required for the subsidiary in
some instances such as in the banking industry, an industry that has been overwhelmed
by the frequency and extent of merger activity in recent years.
The valuation implied by the price of the stock to the parent company is “pushed
down” to the subsidiary and used to restate its assets (including goodwill) and
­liabilities in its separate financial statements. If all the voting stock is purchased, the
assets and liabilities of the subsidiary company are restated so that the excess of
the restated amounts of the assets (including goodwill) over the restated amounts
of the liabilities equals the purchase price of the stock. Push down accounting is based
on the notion that the basis of accounting for purchased assets and liabilities should be
the same regardless of whether the acquired company continues to exist as a separate
subsidiary or is merged into the parent company’s operations. Thus, under push down
accounting, the parent company’s cost of acquiring a subsidiary is used to establish a
new accounting basis for the assets and liabilities of the subsidiary in the subsidiary’s
separate financial statements. Because push down accounting has not been addressed
in authoritative pronouncements of the FASB or its predecessors, practice has been
inconsistent. Some acquired companies have used a new push down basis, and others,
in essentially the same circumstances, have used preacquisition book values.

Arguments for and against Push Down Accounting

Proponents of push down accounting believe that a new basis of accounting should
be required following an acquisition transaction that results in a significant change
in the ownership of a company’s outstanding voting stock. In essence, they view the
transaction as if the new owners had purchased an existing business and established
a new company to continue that business. Consequently, they believe that the parent
company’s basis should be imputed to the subsidiary because the new basis provides
more relevant information for users of the subsidiary’s separate financial statements.
In addition, current GAAP requires that assets acquired, liabilities assumed, and any
noncontrolling interest in the acquiree at the acquisition date be measured at fair value.
To provide symmetry, the separate financial statements of the subsidiary should be pre-
sented in the same manner.

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 2 Chapter 5 Allocation and Depreciation of Differences Between Implied and Book Values (Online)

Those who oppose push down accounting believe that, under the historical cost
concept, a change in ownership of an entity does not justify a new accounting basis in
its financial statements. Because the subsidiary did not purchase assets or assume lia-
bilities as a result of the transaction, the recognition of a new accounting basis based
on a change in ownership, rather than on a transaction on the part of the subsidiary,
represents a breach in the historical cost concept in accounting. They argue further that
implementation problems might arise. For example, noncontrolling stockholders may
not have meaningful comparative financial statements. In addition, restatement of the
financial statements may create problems in determining or maintaining compliance
with various financial restrictions under debt agreements.
Push down accounting is an issue only if the subsidiary is required to issue separate
financial statements for any reason, for example, because of the existence of noncontrol-
ling interests or financial arrangements with nonaffiliates. Three important factors that
should be considered in determining the appropriateness of push down accounting are:

1. Whether the subsidiary has outstanding debt held by the public.

2. Whether the subsidiary has outstanding, a senior class of capital stock not acquired
by the parent company.
3. The level at which a major change in ownership of an entity should be deemed to
have occurred, for example, 100%, 90%, 51%.

Public holders of the acquired company’s debt need comparative data to assess the
value and risk of their investments. These public holders generally have some expressed
(or implied) rights in the subsidiary that may be adversely affected by a new basis of
accounting. Similarly, holders of preferred stock, particularly if the stock includes a par-
ticipation feature, may have their rights altered significantly by a new basis of accounting.
Views on the percentage level of ownership change needed to apply a new basis
of accounting vary. Some believe that the purchase of substantially all the voting
stock (90% or more) should be the threshold level; others believe that the percentage
level of ownership change should be that needed for control; for example, more than
50%. A related problem involves the amounts to be allocated to the individual assets
and liabilities, noncontrolling interest, and goodwill in the separate statements of the
subsidiary. Some believe that values should be allocated on the basis of the fair value
of the subsidiary as a whole imputed from the transaction. Thus, if 80% of the voting
stock is acquired for $32 million, the fair value of the net assets would be imputed to
be $40 million ($32 million / .80), and values would be allocated on that basis. This
approach will result in the assignment of the same values to assets and liabilities on
the books of the subsidiary as that previously illustrated in the workpaper entry to
allocate the difference between implied and book value in the consolidated statements
workpaper. Others believe that values should be allocated on the basis of the propor-
tional interest acquired. They believe that new values should be reflected on the books
of the subsidiary only to the extent of the price paid in the transaction. Thus, if 80% of
a company is acquired for $32 million, the basis of the subsidiary’s net assets would be
adjusted by the difference between the price paid and the book value of an 80% interest.

Status of Push Down Accounting

On January 17, 2013, FASB’s Emerging Issues Task Force discussed push down
accounting and concluded that the strategy for the FASB is to pursue developing a model
under which push down accounting could be applied when an acquirer obtains control
of a reporting entity. The Task Force decided to consider at a future meeting whether

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 Push Down Accounting 3

push down accounting should be mandatory. The Task Force decided that pushdown
accounting would be required for a public business entity if a change-in-control event
causes the entity to become substantially wholly owned by the acquirer. The Task Force
also tentatively decided that both public business entities and nonpublic entities would
have the option to apply push down accounting in their separate financial statements upon
occurrence of a change-in-control event.
As a general rule, the SEC requires push down accounting when the ownership
change is greater than 95% and objects to push down accounting when the owner-
ship change is less than 80%. In addition, the SEC staff expresses the view that the
existence of outstanding public debt, preferred stock, or a significant noncontrolling
interest in a subsidiary might impact the parent company’s ability to control the form
of ownership. In these circumstances, push down accounting, though not required, is
an acceptable accounting method.

Push Down Accounting Illustration

To illustrate the application of push down accounting, we use data presented earlier in
this chapter, with some modifications, as follows:

1. P Company acquired an 80% interest in S Company on January 1, 2020, for

$2,200,000, at which time S Company had capital stock of $1,500,000 and retained
earnings of $500,000. The implied value of S Company is $2, 200, 000 / 80%
$2, 750, 000.
2. The difference between implied and book value ($750,000) is allocated as pre-
sented in Illustration 5‑25.

In this example, we assume that values are allocated on the basis of the fair value
of the subsidiary as a whole, imputed from the transaction.
3. In 2020, S Company reported net income of $45,000.
Note that the net income of S Company ($45,000) is $80,000 less than the
amount of income reported in Illustration 5-9 because the effect of the deprecia-
tion of the difference between implied and book value is recorded on the books of
S Company under push down accounting. This difference of $80,000 consists of:
Increase in cost of goods sold $50,000
Increase in depreciation expense ($300,000/10 years) 30,000
$80,000

4. S Company declared a dividend of $20,000 on November 15, payable on Decem-

ber 1, 2020.
5. P Company uses the cost method to record its investment in S Company.

ILLUSTRATION 5-25

Allocation of Difference between Implied and Book Value

Implied (100%)
Cost Basis Push Down Base
Inventory (FIFO basis) $ 40,000 $ 50,000
Equipment (10-year life) 240,000 300,000
Land 120,000 150,000
Goodwill 200,000 250,000
Total $600,000 $750,000

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 4 Chapter 5 Allocation and Depreciation of Differences Between Implied and Book Values (Online)

S Company Book Entries—2020

On January 1, 2020, the date of acquisition, S Company would make the following entry
to record the effect of the pushed down values implied by the purchase of 80% of its stock
by P Company:

Inventory, 1/1 50,000

Equipment 300,000
Land 150,000
Goodwill 250,000
Revaluation Capital 750,000

Assume the following: (1) all beginning inventory was sold during the year; and
(2) equipment has a remaining useful life of 10 years from 1/1/2020. Given these
assumptions, the $50,000 excess cost allocated to beginning inventory would be
included in cost of goods sold when the goods were sold. Similarly, depreciation
expense recorded on S Company’s books would be $30,000 greater if the increase in
equipment value had not been recorded.
A workpaper for the preparation of consolidated financial statements on Decem-
ber 31, 2020, under push down accounting is presented in Illustration 5‑26. Workpaper
elimination entries in general journal form are:

(1) Dividend Income 16,000

Dividends Declared—S Company 16,000
(2) Capital Stock—S Company 1,500,000
Retained Earnings 1/1—S Company 500,000
Revaluation Capital—S Company 750,000
Noncontrolling Interest in Equity 550,000
Investment in S Company 2,200,000

A comparison of Illustration 5‑26 with Illustration 5-4 shows that consolidated net
income as well as the controlling interest in consolidated net income and consolidated
retained earnings are the same. Thus, when values are assigned on the basis of fair
values of the subsidiary as a whole imputed from the transaction, the use of push down
accounting has no effect on the consolidated balances.
Note also that no workpaper entries were necessary in Illustration 5‑26 to allocate
or depreciate the difference between implied and book value since these adjustments
have already been made on S Company’s books.

PROBLEMS

PROBLEM 5-19 Interim Acquisition, Contingent Consideration, Cost Method LO 5 LO 6

(This is a continuation of Problem 4-20.)
Pcost Company purchased 85% of the common stock of Scost Company on April 1, Year 1
for total consideration of $545,000 cash plus $50,000 of contingent consideration as measured

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 Problems 5

ILLUSTRATION 5-26

Cost Method
80% Owned Subsidiary &RQVROLGDWHG6WDWHPHQWV:RUNSDSHU
Push Down Basis 3&RPSDQ\DQG6XEVLGLDU\
IRU<HDU(QGHG'HFHPEHU
P S Eliminations Noncontrolling Consolidated
Income Statement Company Company Dr. Cr. Interest Balances
Sales 3,100,000 2,200,000 5,300,000
Dividend Income 16,000 (1) 16,000
Total Revenue 3,116,000 2,200,000 5,300,000
Cost of Goods Sold 1,700,000 1,410,000 3,110,000
Depreciation—Equipment 120,000 60,000 180,000
Other Expenses 998,000 685,000 1,683,000
Total Cost and Expense 2,818,000 2,155,000 4,973,000
Net/Consolidated Income 298,000 45,000 327,000
Noncontrolling Interest in Income 9,000* 9,000
Net Income to Retained Earnings 298,000 45,000 16,000 —0— 9,000 318,000
Retained Earnings Statement
1/1 Retained Earnings
P Company 1,650,000 1,650,000
S Company 500,000 (2) 500,000
Net Income from above 298,000 45,000 16,000 —0— 9,000 318,000
Dividends Declared
P Company (150,000) (150,000)
S Company (20,000) (1) 16,000 (4,000)
12/31 Retained Earnings to
Balance Sheet 1,798,000 525,000 516,000 16,000 5,000 1,818,000
Balance Sheet
Investment in S Company 2,200,000 (2) 2,200,000
Land 1,250,000 400,000 1,650,000
Equipment (net) 1,080,000 540,000 1,620,000
Other Assets (net) 2,402,000 1,885,000 4,287,000
Goodwill 250,000 250,000
Total 6,932,000 3,075,000 7,807,000
Liabilities 2,134,000 300,000 2,434,000
Capital Stock
P Company 3,000,000 3,000,000
S Company 1,500,000 (2) 1,500,000
Revaluation Capital 750,000 (2) 750,000
Retained Earnings from above 1,798,000 525,000 516,000 16,000 5,000 1,818,000
1/1 Noncontrolling Interest in
Net Assets (2) 550,000 550,000
12/31 Noncontrolling Interest in
Net Assets 555,000 555,000
Total 6,932,000 3,075,000 2,766,000 2,766,000 7,807,000

(*) 20% × $45,000 = $9,000.

(1) To eliminate intercompany dividends.
(2) To eliminate investment account and create noncontrolling interest account.

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 6 Chapter 5 Allocation and Depreciation of Differences Between Implied and Book Values (Online)

according to GAAP at fair value. Both companies have a December 31 year-end. December 31,
Year 1, trial balances for Pcost and Scost were:

At December 31, Year 1

Pcost Scost
Cash $ 30,000 $ 25,000
Accounts Receivables 173,000 135,000
Inventory 232,000 130,000
Treasury Stock at Cost, 500 Shares 48,000
Investment in Scost Company 595,000
Property and Equipment (net) 936,000 519,000
Cost of Goods Sold 1,540,000 754,000
Selling, General, & Administration 320,000 260,000
Other Expenses 96,000 90,000
Dividends Declared      —0—     50,000
Total $3,936,000 $2,011,000

Accounts Payable $ 193,500 $ 130,000

Contingent Consideration 61,000
Dividends Payable —0— 50,000
Common Stock, $5 par Value 270,000 40,000
Other Contributed Capital 900,000 250,000
Retained Earnings, 1/1 355,000 241,000
Sales 2,100,000 1,300,000
Dividend Income     42,500      —0—
Total $3,936,000 $2,011,000

Scost Company declared a $50,000 cash dividend on December 20, Year 1, payable on January
10, Year 2, to stockholders of record on December 31, Year 1. Pcost Company recognized the
dividend on its declaration date. Pcost includes dividend income receivable in the accounts receiv-
able account.
On the acquisition date, the book values and fair values of Scost’s assets and liabilities were
equal with the following exceptions.

Book Value Fair Value

Inventory 116,000 146,000
Property and Equipment 465,000 507,000

Any difference between book value and fair value for property and equipment is depreciated
over seven years. Depreciation expense is reported on the income statement in Selling, General,
and Administration expense. The entire amount of inventory acquired was sold in Year 1.
No payments were made for the earn-out at the end of year 1, and the adjustment to con-
tingent consideration included only interest adjustments (no change in fair value was expected
since the actual and target levels for revenue were equal at the end of year 1).
Both companies report depreciation expense as a component of Selling, General, and
Administration expense on the income statement. For the year ending December 31, Year 1,
Pcost and Scost reported depreciation expense of $96,000 and $72,000, respectively. Both
companies use straight-line and use the full-year option in computing depreciation expense
(i.e., they take a full year’s depreciation on any asset acquired during the year). The following
balance sheet is available for both companies at the beginning of the year of acquisition and the
acquisition date.

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 Problems 7

Pcost Scost Pcost Scost

Balance Sheet 1/1/Year 1 1/1/Year 1 4/1/Year 1 4/1/Year 1
Cash $100,000 $15,000 28,000 11,000
Accounts Receivables 170,000 115,000 124,000 121,000
Inventory 220,000 122,000 229,000 116,000
Investment in Scost Company 0 0 595,000
Property and Equipment    850,000      450,000       850,000   465,000  
Total $1,340,000     $702,000   1,826,000   $713,000  

Accounts and Notes Payable $65,000 $169,000 215,000 156,000

Contingent Consideration 50,000
Dividends Payable — 50,000 —
Capital Stock, $5 par value 220,000 40,000 270,000 40,000
Other Contributed Capital 700,000 250,000 900,000 250,000
Retained Earnings 355,000 241,000 391,000 315,000
Treasury Stock                     (48,000)          — (48,000)
Total $1,340,000     $702,000   $1,826,000 $713,000

Required:
1. Prepare a consolidated workpaper at the end of year 1.
2. Prepare a consolidated statement of cash flows for year 1 (see Chapter 4 for a review of the
consolidated statement of cash flows).
3. Prepare the journal entry on the books of Pcost to account for the change in the contingent
consideration liability for year 1.

PROBLEM 5-20 Interim acquisition, contingent consideration, complete equity method LO 5 LO 6

(This is a continuation of Problem 4-21)
Pequity Company purchased 85% of the common stock of Sequity Company on April 1, Year 1
for total consideration of $545,000 cash plus $50,000 of contingent consideration as measured
according to GAAP at fair value. Both companies have a December 31 year-end. December 31,
Year 1, trial balances for Pequity and Sequity were:

At December 31, Year 1

Pequity Sequity
Cash $ 30,000 $ 25,000
Accounts Receivables 173,000 135,000
Inventory 232,000 130,000
Treasury Stock at Cost, 500 shares 48,000
Investment in Sequity Company 626,875
Property and Equipment (net) 936,000 519,000
Cost of Goods Sold 1,540,000 754,000
Selling, General, & Administration 320,000 260,000
Other Expenses 96,000 90,000
Dividends Declared      —0—     50,000
Total $3,953,875 $2,011,000

Accounts Payable $ 193,500 $ 130,000

Contingent Consideration 61,000
Dividends Payable —0— 50,000
Common Stock, $5 par Value 270,000 40,000

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 8 Chapter 5 Allocation and Depreciation of Differences Between Implied and Book Values (Online)

At December 31, Year 1

Pequity Sequity

Other Contributed Capital 900,000 250,000

Retained Earnings, 1/1 355,000 241,000
Sales 2,100,000 1,300,000
Equity Income     74,375      —0—
Total $3,953,875 $2,011,000

Sequity Company declared a $50,000 cash dividend on December 20, Year 1, payable on Janu-
ary 10, Year 2, to stockholders of record on December 31, Year 1. Pequity Company recog-
nized the dividend on its declaration date. Pequity includes dividend income receivable in the
accounts receivable account.
On the acquisition date, the book values and fair values of Sequity’s assets and liabilities were
equal with the following exceptions.

Book Value Fair Value

Inventory 116,000 146,000
Property and Equipment 465,000 507,000

Any difference between book value and fair value for property and equipment is depreciated
over seven years. Depreciation expense is reported on the income statement in selling, general,
and administration expense. The entire amount of inventory acquired was sold in Year 1.
No payments were made for the earn-out at the end of year 1, and the adjustment to con-
tingent consideration included only interest adjustments (no change in fair value was expected
since the actual and target levels for revenue were equal at the end of year 1).
Both companies report depreciation expense as a component of Selling, General, and
Administration expense on the income statement. For the year ending December 31, Year 1,
Pequity and Sequity reported depreciation expense of $96,000 and $72,000, respectively. Both
companies use straight-line and use the full-year option in computing depreciation expense
(i.e., they take a full year’s depreciation on any asset acquired during the year). The following
balance sheet is available for both companies at the beginning of the year of acquisition and the
acquisition date.

Pequity Sequity Pequity Sequity

Balance Sheet 1/1/Year 1 1/1/Year 1 4/1/Year 1 4/1/Year 1
Cash $100,000 $15,000 28,000 11,000
Accounts Receivables 170,000 115,000 124,000 121,000
Inventory 220,000 122,000 229,000 116,000
Investment in Scost Company 0 0 595,000
Property and Equipment    850,000 450,000   850,000   465,000  
Total $1,340,000 $702,000   1,826,000   $713,000  

Accounts and Notes Payable $65,000 $169,000 215,000 156,000

Contingent Consideration — 50,000
Dividends Payable — 50,000 —
Capital Stock, $5 par value 220,000 40,000 270,000 40,000
Other Contributed Capital 700,000 250,000 900,000 250,000
Retained Earnings 355,00 241,000 391,000 315,000
Treasury Stock                (48,000)         —     (48,000)
Total $1,340,000 $702,000   $1,826,000   $713,000   

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 Problems 9

Required:
1. Prepare a consolidated workpaper at the end of year 1.
2. Prepare a consolidated statement of cash flows for year 1 (see Chapter 4 for a review of the
consolidated statement of cash flows).
3. Prepare the journal entry on the books of Pequity to account for the change in the contingent
consideration liability for year 1.

ASC EXERCISES:  or all ASC exercises indicate as part of your answer: the Codification topic, subtopic, sec-
F
tion, and/or paragraph upon which your answer is based (unless otherwise specified). All ASC
questions require access to the FASB Codification.
ASC5-1 Presentation You are writing a research paper on the accounting for treasury stock. You
wonder if it is possible to treat treasury stock as an asset. If not, you wonder if, over the his-
tory of GAAP, it has ever been acceptable for treasury stock to be classified as an asset (you
vaguely recall reading something in FASB Statement No. 135, paragraph 4).
ASC5-2 Presentation Management changed an accounting method. Several executives would have
qualified for additional bonuses totaling $50,000 in the prior year under the new method. Can
the firm restate the previous year’s income statement to include this expense?
ASC5-3 Objective What is the objective of the statement of cash flows?
ASC5-4 Cross-Reference FASB Statement No. 142 changed the guidance for goodwill and other intan-
gibles. List all the topics in the Codification where this information can be found (i.e., ASC
XXX). (Hint: There are two general topics.)
ASC5-5 Measurement What is a reverse acquisition? How should the consideration transferred in a
reverse acquisition be measured?
ASC5-6 Disclosure When does the SEC staff believe that push down accounting should be
applied? LO 10

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