Question

 Understand and know how to apply the cost principle

 Know and understand how to measure Goodwill (GW), subsequent valuation of GW, and reporting of GW.  Understand and measure capitalization of interest for self-constructed assets; know how to calculate amounts capitalized and amounts expensed.

 Differentiate between non-monetary exchanges with and without commercial substance; know how to measure amounts for non-monetary exchanges with and lacking commercial substance.

 Understand the R&D rules for U.S. GAAP and IFRS; differentiate between internal and external R&D

 Understand the subsequent valuation of PPE consistent with U.S. GAAP

 Understand the valuation options for PPE consistent with IFRS  Know how to apply the revaluation options under IFRS

 Understand and measure amount related to the disposal of PPE

 Know how to apply the different depreciation methods and PPE related changes in principle and estimates

 Distinguish between the equity method, the fair value method, and consolidations

 Know how to apply the equity method (entries, account balances, measurement of related amounts); consider the effect of a mid-year acquisition on income and dividends recognized

 Know and understand how investments accounted for under the fair value method are categorized, measured/valued, recognized, and reported

 Know and understand:

 The nature of bonds; how to calculate the issue price, the periodic interest and amortization under the effective interest method; how to recognize bond-related amounts (issuance, interest, at maturity); how to prepare the related balance sheet presentation. o how issuance between interest periods affects accrual of interest for first period. Understand the limited applicability of straight-line amortization.

 Know how to measure and recognize bond-related amounts for early extinguishment.

 Differentiate between operating and capital leases o Differentiate between the types of capital leases  Know how to prepare lessee’s and lessor’s journal entries

Answer 1

HOW TO CALCULATE GOODWILL
The traditional measurement of goodwill on the acquisition of a subsidiary is the excess of the fair value of the consideration given by the parent over the parent’s share of the fair value of the net assets acquired. This method can be referred to as the proportionate method. It determines only the goodwill that is attributable to the parent company.
The new method of measuring goodwill on the acquisition of the subsidiary is to compare the fair value of the whole of the subsidiary (as represented by the fair value of the consideration given by the parent and the fair value of the non controlling interest) with all of the fair value of the net assets of the subsidiary acquired. This method can be referred to as the gross or full goodwill method. It determines the goodwill that relates to the whole of the subsidiary, ie goodwill that is both attributable to the parent’s interest and the non-controlling interest (NCI).
CONSIDER CALCULATING GOODWILL
Borough acquires an 80% interest in the equity shares of High for consideration of $500. The fair value of the net assets of High at that date is $400. The fair value of the NCI at that date (ie the fair value of High’s shares not acquired by Borough) is $100.
Required
1. Calculate the goodwill arising on the acquisition of High on a proportionate basis.
2. Calculate the gross goodwill arising on the acquisition of High, ie using the fair value of the NCI.
Solution
1. The proportionate goodwill arising is calculated by matching the consideration that the parent has given, with the interest that the parent acquires in the net assets of the subsidiary, to give the goodwill of the subsidiary that is attributable to the parent.
Parent’s cost of investment at the
fair value of consideration given
$500
Less the parent’s share of the fair
value of the net assets of the
subsidiary acquired

(80% x $400)
($320)
Goodwill attributable to the parent $180

2. The gross goodwill arising is calculated by matching the fair value of the whole business with the whole fair value of the net assets of the subsidiary to give the whole goodwill of the subsidiary, attributable to both the parent and to the NCI.
Parent’s cost of investment at the
fair value of consideration given
$500
Fair value of the NCI $100
Less the fair value of the net
assets of the subsidiary acquired
(100% x $400)
($400)
Gross goodwill
$200
Given a gross goodwill of $200 and a goodwill attributable to the parent of $180, the goodwill attributable to the NCI is the difference of $20.
In these examples, goodwill is said to be a premium arising on acquisition. Such goodwill is positive goodwill and accounted for as an intangible asset in the group accounts, and as we shall see be subject to an annual impairment review.
In the event that there is a bargain purchase, ie negative goodwill arises, then this is regarded as a profit and immediately recognised in income.

Explaining the Effective Interest Rate Method
The preferred method for amortizing (or gradually writing off) a discounted bond is the effective interest rate method or the effective interest method. Under the effective interest rate method, the amount of interest expense in a given accounting period correlates with the book value of a bond at the beginning of the accounting period. Consequently, as a bond's book value increases, the amount of interest expense increases.
When a discounted bond is sold, the amount of the bond's discount must be amortized to interest expense over the life of the bond. When using the effective interest method, the debit amount in the discount on bonds payable is moved to the interest account. Therefore, the amortization causes interest expense in each period to be greater than the amount of interest paid during each year of the bond's life.
For example, assume a 10-year $100,000 bond is issued with a 6% semi-annual coupon in a 10% market. The bond is sold at a discount for $95,000 on January 1, 2017. Therefore, the bond discount of $5,000, or $100,000 less $95,000, must be amortized to the interest expense account over the life of the bond.
The effective interest method of amortization causes the bond's book value to increase from $95,000 on January 1, 2017 to $100,000 prior to the bond's maturity. The issuer must make interest payments of $3,000 every six months the bond is outstanding. The cash account is then credited $3,000 on June 30 and December 31.
The Effective Interest Rate Method and Bond Pricing
The effective interest method is used when evaluating the interest generated by a bond because it considers the impact of the bond purchase price rather than accounting only for par value.
Though some bonds pay no interest and generate income only at maturity, most offer a set annual rate of return, called the coupon rate. The coupon rate is the amount of interest generated by the bond each year, expressed as a percentage of the bond's par value.
Par value
Par value, in turn, is simply another term for the bond's face value, or the stated value of the bond at the time of issuance. A bond with a par value of $1,000 and a coupon rate of 6% pays $60 in interest each year.
A bond's par value does not dictate its selling price. Bonds that have higher coupon rates sell for more than their par value, making them premium bonds. Conversely, bonds with lower coupon rates often sell for less than par, making them discount bonds. Because the purchase price of bonds can vary so widely, the actual rate of interest paid each year also varies.
If the bond in the above example sells for $800, then the $60 interest payments it generates each year actually represent a higher percentage of the purchase price than the 6% coupon rate would indicate. Though both the par value and coupon rate are fixed at issuance, the bond actually pays a higher rate of interest from the investor's perspective. The effective interest rate of this bond is $60 / $800, or 7.5%.
If the central bank reduced interest rates to 4%, this bond would automatically become more valuable because of its higher coupon rate. If this bond then sold for $1,200, its effective interest rate would sink to 5%. While this is still higher than newly issued 4% bonds, the increased selling price partially offsets the effects of the higher rate.
Rationale behind Effective Interest Rate Method
In accounting, the effective interest method examines the relationship between an asset's book value and related interest. In lending, the effective annual interest rate might refer to an interest calculation wherein compounding occurs more than once a year. In capital finance and economics, the effective interest rate for an instrument might refer to the yield based on purchase price.
All of these terms are related in some way. For example, effective interest rates are an important component of the effective interest method.
An instrument's effective interest rate can be contrasted with its nominal interest rate or real interest rate. The effective rate takes two factors into consideration: purchase price and compounding. For lenders or investors, the effective interest rate reflects the actual return far better than the nominal rate. For borrowers, the effective interest rate shows costs more effectively.
Put another way, the effective interest rate is equal to the nominal return relative to the actual principal investment.
In terms of bonds, this is the same as the difference between coupon rate and yield.
An interest-bearing asset also has a higher effective interest rate as more compounding occurs. For example, an asset that compounds interest yearly has a lower effective rate than an asset with monthly compounding.
Unlike the real interest rate, the effective interest rate does not take inflation into account. If inflation is 1.8%, a Treasury bond (T-bond) with a 2% effective interest rate has a real interest rate of 0.2%, or the effective rate minus the inflation rate.
Advantages of Using An Effective Interest Rate Figure
The primary advantage of using the effective interest rate figure is simply that it is a more accurate figure of actual interest earned on a financial instrument or investment, or of actual interest paid on a loan, such as a home mortgage.
The effective interest rate calculation is commonly used with regard to the bond market. The calculation provides the real interest rate returned in a given time period, based on the actual book value of a financial instrument at the beginning of the time period. If the book value of the investment declines, then the actual interest earned will decline as well.
Investors and analysts often use effective interest rate calculations to examine premiums or discounts related to government bonds, such as the 30-year U.S. Treasury bond, although the same principles apply to trading corporate bonds. When the stated interest rate on a bond is higher than the current market rate, then traders are willing to pay a premium over the face value of the bond. Conversely, whenever the stated interest rate is lower than the current market interest rate for a bond, the bond trades at a discount to its face value.
Actual Interest Earned
The effective interest rate calculation reflects actual interest earned or paid over a specified time frame. It is considered preferable to the straight-line method of figuring premiums or discounts as they apply to bond issues, because it is a more accurate statement of interest from the beginning to the end of a chosen accounting period (the amortization period).
On a period-by-period basis, accountants regard the effective interest method as far more accurate for calculating the impact of an investment on a company's bottom line.
To obtain this increased accuracy, however, the interest rate must be recalculated every month of the accounting period; these extra calculations are a disadvantage of using the effective interest rate. If an investor uses the simpler straight-line method to calculate interest, then the amount charged off each month doesn't vary; it is the same amount every month.
The Bottom Line
Whenever an investor buys, or a financial entity such as the U.S. Treasury or a corporation sells, a bond instrument for a price that is different from the bond's face amount, then the actual interest rate being earned is different from the bond's stated interest rate. The bond may be trading at a premium or at a discount to its face value. In either case, the actual effective interest rate differs from the stated rate. For example, if a bond with a face value of $10,000 is purchased for $9,500 and the interest payment is $500, then the effective interest rate being earned is not 5%, but 5.26% ($500 divided by $9,500).
When it comes to loans such as a home mortgage, the effective interest rate is also known as the annual percentage rate. It takes into account the effect of compounding interest, along with all other costs that the borrower pays for the loan.
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Difference between captal lease and operating lease

Leasing equipment is a common alternative to purchase. Of the two kinds of leases - capital leases and operating leases - each is used for different purposes and results in differing treatment on the accounting books of a business.

Capital Leases

A capital lease is a lease of business equipment which represents ownership and is reflected on the company's balance sheet as an asset.

A capital lease, in contrast to an operating lease, is treated as a purchase from the standpoint of the person who is leasing and as a loan from the standpoint of the person who is offering the lease, for accounting purposes.

Capital leases are used for long-term leases and for items that not become technologically obsolete, such as many kinds of machinery.

Capital leases give the lessee (the person who is leasing) the benefits and drawbacks of ownership, so they are considered as assets, and they may be depreciated.

These leases are considered as debts of the lessee.

In order to be considered a capital lease, the Financial Accounting Standards Board (FASB) requires that at least one of these conditions must be met:

Title to the equipment passes automatically to the lessee by the end of the lease term

The lease contains an option to purchase the equipment at the end of the lease for substantially less than fair market value; sometimes this is a $1 purchase

The term of the lease is greater than 75% of the useful life of the equipment

The present value of the lease payments is greater than 90% of the fair market value of the equipment.

As you can see, with a capital lease you are in essence paying the cost of the car over the term of the lease.

Capital Leases and Depreciation

Because they are considered assets, capital leases may be eligible for depreciation.

If you want to lease but want the benefit of depreciating the asset, check with your tax adviser before you enter into a capital lease, to be sure it meets the criteria to be depreciable. Some capital leases may not be eligible for accelerated depreciation (bonus depreciation or Section 179 deductions).

Operating Leases

Operating leases, sometimes called service leases are used for short-term leasing and often for assets that are high-tech or in which the technology changes often, like computer and office equipment.

The lessee uses the property but does not take on the benefits or drawbacks of ownership, which are retained by the lessor.

The rental cost of an operating lease is considered an operating expense.

The Bargain Purchase Option in Leases

A capital lease must not include a bargain purchase option, while operating leases often include this option. A bargain purchase option is just like it sounds - an option to buy the equipment or vehicle at the end of the lease at a bargain price.

Which is Better, a Capital Lease or an Operating Lease?

As usual, it depends. If you are leasing a high-technology piece of equipment, you will probably have an operating lease. For example, if you are leasing copiers for your office, you probably have an operating lease.

If you are leasing a piece of machinery which you intend to use for a long time, you probably have a capital lease.

For car leases, many businesses use operating leases because the cars are being used heavily and they are turned over for new models at the end of the lease. But an operating lease doesn't give you the ability to depreciate the asset.

Benefits and Drawbacks of Equipment Leasing

In general, businesses lease equipment to fund their business without having to finance a purchase of equipment. For example, a business that uses vans or trucks for deliveries can lease those vehicles without having to get a loan or tie up funds for the purchase.

The drawbacks to equipment leasing are that leases are usually more expensive on a monthly basis and some leases are not eligible for tax-saving depreciation allowances.