Question

Red Co. acquired 100% of Brown, Inc. on January 1, Year1. On that date, Brown had: Book value Fair Value expected life Land 42,000 52,000 forever Building 200,000 600,000 20 years Equipment 350,000 250,000 10 years What will be the net effect on consolidated expenses for the year ended December 31, Year 1 related to the acquisition allocations of Brown?

a. An increase in total expenses of $10,000

b. A reduction in total expenses of $10,000

c. An increase in total expense of $30,000

d. A reduction in total expenses of $30,000

Answer 1

In the case of the fair value, there will be adjustments regarding extra depreciation.

• In the case of land, there will be no depreciation charged.
• In the case of Building, there is a fair value upward occurred during the year so, we have to charge an extra depreciation (expense).

Extra depreciation = fair value movement/remaining useful life

= $400,000/20 years

= $20,000 [since the expenses are increasing, we can denominate as possitive]

• Equipment, there is a fair value downward, instead of extra depreciation, we will have reduction in depreciation, so we have to reduce the extra depreciation already charged in the books of accounts.

  Reduction in depreciation expense = $100,000 fair value downward/10 year life

= ($10,000) [there is a reduction in depreciation expense, so we deduct it]

Net effect = $20,000 increase in expense - $10,000 decrese in expense

= $10,000 increase in expense.