chapter 04 - accounting managerial

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Jeter ● Chaney

Prepared by Sheila Ammons, Austin Community College

Advanced Accounting

Consolidated

Financial Statements After Acquisition

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Learning Objectives

• Describe the accounting treatment required under

current GAAP for varying levels of influence or control by investors.

• Prepare journal entries on the parent’s books to account for an investment using the cost method, the partial

equity method, and the complete equity method.

• Understand the use of the workpaper in preparing consolidated financial statements.

• Prepare a schedule for the computation and allocation of

the difference between implied and book values.

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Learning Objectives

•

Prepare the workpaper eliminating entries for the year of

acquisition (and subsequent years) for the cost and equity methods.

•

Describe how to account for interim acquisitions of subsidiary stock at the end of the first year.

•

Explain how the consolidated statement of cash flows differs from a single firm’s statement of cash flows.

•

Understand how the reporting of an acquisition on the consolidated statement of cash flows differs when stock is issued instead of cash payment.

•

Describe some of the differences between U.S. GAAP and IFRS in accounting for equity investments.

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Investments in Stock

•

Investments in voting stock may be consolidated, or separately reported at

–

cost,

–

fair value, or

–

carrying value of equity.

•

The method of reporting adopted depends on a number of factors including

–

size of investment

–

extent to which the investor exercises control over activities of the investee

–

marketability of the securities.

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Accounting for Investments by the Cost, Partial Equity, and Complete Equity Methods

0 ---20% --- 50% --- 100%

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No significant influence

Significant influence (no

control)

Effective control

Investment valued using the

“cost” method but with adjustments to

fair value.

Investment measured under

equity method

Investment recorded using cost method or

equity method (investment eliminated in consolidation) Ownership Percentages

Ownership Percentages

LO 1 Varying levels of ownership are accounted for differently.

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Accounting for Investments by the Cost, Partial Equity, and Complete Equity Methods

• When a company owns a sufficient amount of another

company’s stock to have significant influence (usually at least 20%), but not enough to effectively control the other

company (less than 50% in most cases), the equity method is required.

• Under FASB ASC paragraph 825-10-25-2, these equity

investments may alternatively be carried at fair value under an irrevocable election to do so.

• Once the investor is deemed to have effective control over the other company (with or without a majority of stock

ownership), consolidated statements are required.

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Accounting for Investments by the Cost, Partial Equity, and Complete Equity Methods

• The parent company must account for its investment income from the subsidiary in its own books by one of the methods used for accounting for investments.

• Consolidated financial statements will be identical, regardless of method used.

• However, if the parent issues parent-only financial

statements, the complete equity method should be used for investees over which the parent has either

significant influence or effective control.

LO 1 Varying levels of ownership are accounted for differently.7

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E4-1: Percy Company purchased 80% of the outstanding voting shares of Song Company at the beginning of 2014 for $387,000. At the time of purchase, Song Company’s total stockholders’ equity amounted to

$475,000. Income and dividend distributions for Song Company from 2014 through 2016 are as follows:

Required: Prepare journal entries for Percy Company from the date of purchase through 2016 to account for its investment in Song Company under each of the following assumptions:

Accounting for Investments by the Cost

Method

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LO 2 Journal entries for Parent using cost method.

Investment in Song 387,000

Cash 387,000 2014

Cash 20,000

Dividend income (.8 x $25,000) 20,000

E4-1: A. Percy Company uses the cost method to record its investment.

Accounting for Investments by the Cost Method

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Cash 40,000 Dividend income (.8 x $50,000) 40,000 2015

Cash 28,000

Investment in Song (.8 x $35,000) 28,000 2016

(liquidating dividend)

E4-1: A. Percy Company uses the cost method to record its investment.

Accounting for Investments by the Cost

Method

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E4-1: B. Percy Company uses the partial equity method to record its investment.

LO 2 Journal entries for Parent using partial equity method.

Cash 387,000 2014

Equity income (.8 x $63,500) 50,800

Cash 20,000

Investment in Song (.8 x $25,000) 20,000

Accounting for Investments by Partial Equity

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2015 Investment in Song 42,000 Equity income (.8 x $52,500) 42,000

Cash 40,000

Accounting for Investments by Partial

Equity

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2016 Equity loss (.8 x $55,000) 44,000 Investment in Song 44,000

Cash 28,000

LO 2 Journal entries for Parent using partial equity method.

Accounting for Investments by Partial Equity

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E4-1: C. Percy Company uses the complete equity method to record its investment. The difference between book value of equity acquired and the value implied by the purchase price was attributed solely to an excess of market over book values of depreciable assets, with a

remaining life of 10 years.

The complete equity method is usually required to report common stock investments in the 20% to 50% range, assuming the investor has the

ability to exercise significant influence and does not have effective control over the investee.

Accounting for Investments by Complete

Equity

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E4-1: C. Percy Company uses the complete equity method to record its investment.

LO 2 Journal entries for Parent using complete equity method.

Cash 387,000 2014

Equity income (.8 x $63,500) 50,800

Cash 20,000

Accounting for Investments by Complete Equity

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Equity income ($7,000 / 10 yrs.) 700 Investment in Song 700

2014

A journal entry is required to adjust for depreciation related to the excess of market over book values of depreciable assets.

Cost of investment $387,000

Book value acquired ($475,000 x 80%) 380,000 Difference between Cost and Book value $ 7,000

Accounting for Investments by Complete

Equity

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LO 2 Journal entries for Parent using complete equity method.

2015 Investment in Song 42,000

Equity income (.8 x $52,500) 42,000

Cash 40,000

Investment in Song (.8 x $50,000) 40,000 Equity income ($7,000 / 10 yrs.) 700

Investment in Song 700

Accounting for Investments by Complete Equity

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2016 Equity Loss (.8 x $55,000) 44,000 Investment in Song 44,000

Cash 28,000

Investment in Song (.8 x $35,000) 28,000 Equity income ($7,000 / 10) 700

Investment in Song 700

Accounting for Investments by Complete

Equity

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LO 3 Use of workpapers.

Consolidated Statements After Acquisition

• On the date of acquisition, the only relevant financial statement is the consolidated balance sheet.

• After acquisition, a complete set of consolidated

financial statements must be prepared for the affiliated group:

– Income Statement,

– Retained Earnings Statement, – Balance Sheet, and

– Statement of Cash Flows.

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Year of Acquisition—Cost Method

• P4-8: On January 1, 2012, Parker Company purchased 95%

of the outstanding common stock of Sid Company for

$160,000. At that time, Sid’s stockholders’ equity consisted of common stock, $120,000; other contributed capital,

$10,000; and retained earnings, $23,000.

• Required: Prepare a consolidated statements workpaper on A. Dec. 31, 2012.

B. Dec. 31, 2013.

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LO 4 Preparing Computation and Allocation (CAD) Schedule.21

P4-8: Begin the consolidating process by preparing a Computation and Allocation Schedule, as follows:

Difference between implied and book values is established only at the date of acquisition.

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P4-8: A. 2012 Year of Acquisition On December 31, 2012, the

two companies’ trial balances were as follows at right:

Required A. Prepare a consolidated statements

workpaper on December 31, 2012.

Consolidated Statements After

Acquisition

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P4-8: A. 2012 Year of Acquisition

LO 5 Workpapers eliminating entries.

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1. Each section of the workpaper represents one of three consolidated financial statements.

2. Elimination of the investment account.

Consolidated Statements After Acquisition

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Workpaper Observations

Common stock 120,000

Other contributed capital 10,000

Retained earnings, 1/1 23,000

Difference between Implied and Book 15,421 Noncontrolling interest in equity 8,421

Investment in Sid 160,000

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3. Allocation of the difference between implied and book value:

Workpaper Observations (continued)

Goodwill 15,421

Difference between Implied and Book Value 15,421

4. Elimination of intercompany dividends

Dividend income 19,000

Dividends declared – Sid Company 19,000

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5. Noncontrolling interest in consolidated net income:

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Workpaper Observations (continued)

Internally generated income of Sid Company $26,000

Noncontrolling percentage owned 5%

Noncontrolling interest in income $ 1,300

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6. Consolidated retained earnings:

Consolidated Statements After Acquisition

Parker Company’s retained earnings, 1/1 $ 40,000

+ Parker’s income 129,000

- Dividends from Sid Company - 19,000

+ Parker’s percentage of Sid income (95%) 24,700

- Parker’s dividends declared - 20,000

Parker Company’s retained earnings, 12/31 $154,700

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7. Total eliminations for all three sections are in balance.

8. To calculate the noncontrolling interest in net assets or equity at year-end, compute the following:

Consolidated Statements After Acquisition

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NCI at Acquisition Date $ 8,421

+ NCI share of Sid income ($26,000 x 5%) 1,300

- NCI share of Sid dividends ($20,000 x 5%) -1,000 Noncontrolling Interest in Equity $ 8,721

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On December 31, 2013, the two companies’ trial balances were as follows at right:

Required B. Prepare a consolidated statements

Consolidated Statements After Acquisition

P4-8: B. 2013

After Year of

Acquisition – Cost

Method

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LO 5 Workpapers eliminating entries after acquisition (cost method).31

P4-8: B. 2013 After Year of Acquisition

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P4-8: B. 2013 After Year of Acquisition

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1. Before elimination of the investment account, a workpaper entry is made to the investment account and Parker Company’s beginning retained earnings to recognize Parker’s share of the cumulative undistributed income or loss of Sid Company from the date of acquisition to the beginning of the current year as follows:

Consolidated Statements After Acquisition

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LO 5 Workpapers eliminating entries after acquisition (cost method).

Investment in Sid Company 5,700

Retained earnings, 1/1 5,700

($29,000 – $23,000 ) ^X .95 = $5,700 Entry to establish Reciprocity

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• The following workpaper entries are also made:

1) Eliminate investment in Sid Company.

2) Eliminate intercompany dividends.

3) Allocate difference between cost and book value.

4) All (100%) of Sid’s revenues, expenses, assets, and liabilities are included in the consolidated totals.

The noncontrolling interest’s share of income and

net assets are shown as separate line items.

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Recording Investments – Equity Method

Investment Carried at Equity—Year of Acquisition

P4-12: On January 1, 2012, Parker Company purchased 90% of the outstanding common stock of Sid Company for $180,000. At that time, Sid’s stockholders’ equity consisted of common stock,

$120,000; other contributed capital, $20,000; and retained earnings,

$25,000. Assume that any difference between book value of equity and the value implied by the purchase price is attributable to land.

• Required: Prepare a consolidated statements workpaper on A. Dec. 31, 2012.

B. Dec. 31, 2013.

LO 5 Workpaper eliminating entries (equity method).35

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P4-12: Begin the consolidating process by preparing a Computation and Allocation Schedule, as follows:

Difference between implied and book values is

Recording Investments – Equity

Method

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On December 31, 2012, the two companies’ trial balances were as follows:

Required A. Prepare a consolidated statements

Recording Investments – Equity Method

P4-12: A. 2010 Year of Acquisition

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Recording Investments – Equity Method

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LO 5 Workpaper eliminating entries (equity method).

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• The following workpaper entries were made:

To eliminate the account “equity in subsidiary income” and intercompany dividends.

To eliminate the investment account against subsidiary equity.

To distribute the difference between implied and

book value of equity acquired.

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On December 31, 2013, the two companies’ trial balances were as follows at right:

Required B. Prepare a consolidated statements

P4-12: B. 2013

Investment Carried at Equity—After Year of Acquisition

Parker Sid

Cash $ 70,000 $ 20,000

Accounts receivable 60,000 35,000 Inventory 40,000 30,000 Investment in Sid 193,500 - Plant and equipment 125,000 90,000

Land 48,500 45,000

Dividends declared 20,000 15,000 Cost of goods sold 160,000 65,000 Operating expenses 35,000 20,000 Total debits $ 752,000 $ 320,000 Accounts payable $ 16,500 $ 16,000 Other liabilities 15,000 24,000 Common stock 200,000 120,000 Other contributed capital 70,000 20,000 Retained earnings 168,000 30,000

Sales 260,000 110,000

Equity in subsidiary income 22,500 - Total credits $ 752,000 $ 320,000

Recording Investments – Equity Method

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P4-12: B. 2013 After Year of Acquisition

Recording Investments – Equity

Method

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P4-12: B. 2013 After Year of Acquisition

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Interim Acquisitions of Subsidiary Stock

• FASB requires that the consolidated financial statements include the subsidiary’s revenues, expenses, gains, and losses only from the date of acquisition (FASB ASC paragraph 810-10-45-4).

• To accomplish this, the subsidiary usually closes the books on the date of acquisition

– i.e. preacquisition income is closed to retained

earnings.

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LO 6 Interim acquisitions of subsidiary stock.45

Equity Method—

Interim Purchase

Pillow Company purchased 90% of the common stock of Satin Company on May 1, 2011, for a cash payment of

$474,000. December 31, 2011, trial balances for Pillow and Satin were:

P4-15:

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Interim Acquisitions of Subsidiary Stock

P4-15:

• Satin Company declared a $60,000 cash dividend on December 20, 2011, payable on January 10, 2012, to stockholders of record on December 31, 2011. Pillow

Company recognized the dividend on its declaration date.

Any difference between book value and the value implied by the purchase price relates to subsidiary land, included in

property and equipment. Income is earned evenly throughout the year.

• Required: Prepare a consolidated statements workpaper at

December 31, 2011.

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P4-15: Computation and Allocation of Difference between Cost and Book Value Acquired:

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P4-15: Workpaper – Interim Basis, Partial Equity Method

Interim Acquisitions of Subsidiary

Stock

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P4-15: Workpaper – Interim Basis, Partial Equity Method

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Consolidated Statement of Cash Flows

Peculiarities:

• When the company is reporting on a consolidated basis, the statement of cash flows must also be presented on a consolidated basis.

• The starting point for the consolidated cash flow statement is the

consolidated income statement and comparative consolidated balance sheets.

– Thus, the preparation of the consolidated statement of cash flows will be the same, regardless of how the parent accounts for its investment (cost, partial equity, or complete equity method).

• This is true because the final product (the consolidated financial statements) is always the same if consolidated procedures are done correctly.

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Consolidated Statement of Cash Flows

Peculiarities (continued):

1. If the statement of cash flows starts with consolidated net income, then the noncontrolling interest is already included and need not be added back.

2. Subsidiary dividends paid to the noncontrolling stockholders must be included with dividends paid by the parent company when calculating cash outflow from financing activities.

3. Subsidiary stock acquired directly from the subsidiary represents an intercompany cash transfer that does not affect the total cash balance of the consolidated group. If the acquisition is an open market

purchase, it does represent such an outflow.

LO 7 Peculiarities of Consolidated Statement of Cash Flows.51

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Consolidated Statement of Cash Flows

The preparation of the consolidated statement of cash flows in the year of acquisition is complicated slightly because the

comparative balance sheets at the beginning and end of the current year are dissimilar.

1.Any cash spent or received in the acquisition itself should be reflected in the Investing activities section.

2.Assets and liabilities of the subsidiary at the date of

acquisition must be added to those of the parent at the

beginning of the current year.

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Compare U.S. GAAP and IFRS

LO 9 Differences between U.S. GAAP and IFRS. 53

Application of the Equity Method

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LO 9 Differences between U.S. GAAP and IFRS.