acct 501 by professor hsieh chapter consolidated financial statements: subsequent to date of...

ACCT 501by Professor Hsieh

Chapter

Consolidated Financial Statements: Subsequent to Date of Purchase-

Type Business Combination

Consolidated FS-Subsequent to date of purchase type

2

Objectives of this Chapter

Prepare the consolidated financial statements for the parent company and its subsidiaries for the years following business combination for purchase-type business combination For wholly owned purchased

subsidiaries For partially owned purchased

subsidiaries


3

Accounting for Operating Results of wholly Owned Purchased Subsidiaries

In accounting for the operating results of purchased subsidiaries, a parent company may choose the equity method or the cost method of accounting.


4

Equity Method

The parent company recognizes its share of the subsidiary’s net income or loss and adjusted for the depreciation and amortization of the step up of a purchased subsidiary’s net assets on the date of business combination. The parent company also recognizes its share of dividends declared by the subsidiary.


5

Equity Method (contd.)

Thus, the equity method is consistent with the accrual basis accounting. Equity method emphasizes the economic substance of the parent-subsidiary. Dividends declared by subsidiaries are not revenue to the parent company, rather, they are a liquidation of a portion of the parent company’s investment in the subsidiary.


6

Cost Method

Under this method, the parent company accounts for the operations of a subsidiary only to the extend that dividends are declared by the subsidiary. This method emphasizes the legal form of the parent-subsidiary relationship.


7

Choosing Between Equity Method and Cost Method

Consolidated financial statement amounts are the same regardless of whether a parent company uses the equity method or the cost method to account for a subsidiary’s operations. The differences are in the working paper elimination.


8

Choosing Between Equity Method and Cost Method (contd.)

Equity method is appropriate for both pooled subsidiaries and purchased subsidiaries. The cost method is only appropriate for purchased subsidiaries.


9

Example of Equity Method for wholly Owned Purchased Subsidiary for First Year after Business Combination (textbook p286-296)

Assumed that Palm Corporation had used purchase accounting for the December 31, 1999, business combination with its wholly owned subsidiary- Starr Company. Starr had a net income of $60,000 (income statement is on p293 of the textbook) for the year ended December 31, 2000.


10

Example of Equity Method for wholly Owned Purchased Subsidiary for First Year after Business Combination (contd.)

On December 20, 2000, Starr’s board of directors declared a cash dividend of $0.60 a share on the 40,000 outstanding shares of common stock owned by Palm The divided was payable January8, 2001, to stockholders recorded December 29, 2000.


11

Example of Equity Method for wholly Owned Purchased Subsidiary for First Year after Business Combination (contd.) Starr’s December 20, 2000, journal entry to

record the dividend declaration is as follows: 12/20

Dividends Declared 24,000Intercompany Dividend payable 24,000

The intercompany dividend payable account must be eliminated in the preparation of consolidated financial statements for the year 2000.


12

Example of Equity Method for wholly Owned Purchased Subsidiary for First Year after Business Combination (contd.) Under the equity method, Palm Corp.

prepares the following journal entries to record the dividend and net income of Starr for the year ended 12/31/2000: 12/20/00

Intercompany Dividend Receivable 24,000

Investment in Starr Company Stock24,000

To record the dividends declared by Starr.


13

Example of Equity Method for wholly Owned Purchased Subsidiary for First Year after Business Combination (contd.)

12/31/00Investment in Starr Company Stock 60,000

Intercompany Investment Income60,000

To record the Palm’s share (100%) of net income onStarr under equity method


14

Adjustment of Purchased subsidiary’s Net Income

Since Palm’s acquisition of Starr is accounted for using the purchase method, adjustments are needed to adjust Starr’s net income for depreciation and amortization attributable to the step up of Starr’s net assets on 12/31/99.


15

Adjustment of Purchased subsidiary’s Net Income (contd.)

Assumed that on 12/31/99, differences between the current fair values and carrying amounts of Starr’s net assets were as follows (also see p236 and p241 of chapter 6 of the textbook):


16


Inventories (FIFO) $ 25,000Plant assets (net)

Land $15,000Building(eco. life 10 yrs.) 30,000Machinery(eco. life 10yrs.) 20,000 65,000

Patent (eco. life 5 yrs.) 5,000Goodwill (eco. life 30 yrs.) 15,000

Total $110,000


17

Adjustment of Purchased subsidiary’s Net Income (contd.) Palm prepares the following journal entry to

account for the depreciation and amortization of the step up on Starr’s net assets:

12/31/2000Intercompany Investment Income 30,500

Investment in Starr Company Stock 30,500


18

Adjustment of Purchased subsidiary’s Net Income (contd.) The annual depreciation and amortization of

the step up are as follows:Inventory (to cost of goods sold) $25,000Building (30,000/15) 2,000Machinery (20,000/10) 2,000Patent (5,000/5) 1,000Goodwill (15,000/30) 500Total depr. And amort. For year 2000 $30,500

(income tax effects are disregarded)


19

Adjustment of Purchased subsidiary’s Net Income (contd.) After the three foregoing journal entries,

Palm Corp.’s Investment in Starr Company’s Common Stock and intercompany Investment Income accounts are as follows:

Investment in Starr’s Common Stock

12/31/99 450,000 a

12/31/99 50,000 b

12/31/00 60,000 d 24,000 c 12/20/0030,500 e 12/31/00

12/31/00 505,000


20


a. Issuance of common stock (by Palm) in the acquisition of Starr.

b. Direct out-of-pocket costs of business combination.

c. Recognition of dividend declared by the subsidiary-Starr.

d. Recognition of wholly owned subsidiary’s (Starr) net income.

e. Recognition of depre. and amor. on the step-up of Starr’s net assets.


21


Intercompany Investment Income

60,000 a 12/20/00

12/31/00 30,500 b

29,500


22

Development of the Elimination

Analysis of Investment in Starr Stock account (for the year ended 12/31/2000)

Carrying Amount.

Step-up Total

Beginning Balances (on 12/31/99)

$390,000 $110,000 $500,000

Net Income(Starr) 60,000 60,000

Amort. On Step-up (30,500) (30,500)

Dividends Declared by Starr

(24,000) (24,000)

Ending Balance $426,000 $79,500 $505,000


23

Development of the Elimination (contd.) Note:

1. The ending balance on the carrying amount (book value),$426,000, equals the balance the total stockholder’s equity of Starr on 12/31/2000 as follows (see balance sheet section of Starr on p293 of textbook):


24

Development of the Elimination (contd.)

Common Stock,$5 par $200,000Additional Paid-in Capital 58,000Retained Earnings (132,000+60,000-24,000)

168,000

Total Stockholder’s Equity $426,000


25

Development of the Elimination (contd.) The $79,500 balance on the Step-up

column represents the unamortized excess amount (the difference between the current fair value of net assets and the carrying amount). The details are in the following table:


26

Development of the Elimination (contd.)

Balances, Dec.31,1999

Amort. for Year 2000

Balances, Dec. 31,2000

Inventories $ 25,000 $(25,000)

Plant assets(net):

Land $ 15,000 $15,000

Building 30,000 $ (2,000) 28,000 Machinery 20,000 (2,000) 18,000

Total plant assets $ 65,000 $ (4,000) $61,000

Patent $ 5,000 $ (1,000) $ 4,000Goodwill 15,000 (500) 14,500

Totals $110,000 $(30,500) $79,500


27

Palm Corp. and subsidiary Working Paper Elimination (on 12/31/2000)

All three basic financial statements (the income statement, the statement of retained earnings and the balance sheet) must be consolidated for accounting period following the date of a purchase-type business combination.The items that must be included in the elimination are:


28

Palm Corp. and subsidiary Working Paper Elimination (on 12/31/2000) (contd.)

1)The subsidiary’s beginning balance of stockholder’s equity accounts and its dividends and parent’s investment account;

2)the parent’s intercompany investment income ;

3)unamortized current fair value excess of the subsidiary;

4)certain operating expense o the subsidiary.


29


Assuming that Starr allocates machinery depreciation and patent amortization entirely to cost of goods sold, goodwill amortization entirely to operating expense and building depreciation 50% each to cost of goods sold and operating expenses, the working paper elimination (in journal entry format) for Palm and subsidiary on 12/31/2000 is as follows:


30


Common Stock-Starr 200,000

Additional Paid-in Capital-Starr 58,000

Retained Earnings-Starr 132,000

Investment Income-Palm 29,500

Plant Assets (net)-Starr ($65,000-4,000) 61,000Patent (net)-Starr ($5,000-1,000) 4,000

Goodwill (net)-Starr ($15,000-500) 14,500

Cost of Goods Sold-Starr 29,000

Operating Expenses-Starr 1,500

Investment in Starr Common Stock 505,000Dividends Declared-Starr 24,000


31


Note:

1. Income tax effects are disregarded

2. the computation of cost of goods sold and operating expense are as follows:


32


Cost of Goods Sold

Operating Expenses

Inventories sold $25,000

Building depreciation 1,000 $1,000

Machinery depreciation 2,000

Patent amortization 1,000

Goodwill amortization 500

Totals $29,000 $1,500


33

Equity Method: Wholly Owned Subsidiary Subsequent to Date of Purchase-type Business Combination (on p293 of textbook)

PALM CORPORATION AND SUBSIDIARYWorking paper for Consolidated Financial Statements

For Year Ended December 31,2000Income Statement Palm

CorporationStarr

CompanyEliminations

IncreaseConsolidated

Revenue:

Net Sales 1,100,000 680,000 1,780,000

Intercompany investment income 29,500 (a)(29,500)

Total revenue 1,129,500 680,000 (29,500) 1,780,000Costs and expenses:

Cost of good sold 700,000 450,000 (a) 29,000 1,179,000 Operating expenses 217,667 130,000 (a) 1,500 349,167 Interest expenses 49,000 49,000

Income taxes expense 53,333 40,000 93,333

Total costs and expenses 1,020,000 620,000 30,500* 1,670,500

Net income 109,500 60,000 (60,000) 109,500


34

Equity Method: Wholly Owned Subsidiary Subsequent to Date of Purchase-type Business Combination (contd.)


For Year Ended December 31,2000

(Continued)

Statement of Retained Earnings

Palm Corporation

Starr Company

Eliminations Increase

Consolidated

Retained earnings, beginning of year 134,000 132,000 (a) (132,000) 134,000Net income 109,500 60,000 (60,000) 109,500

Subtotal 243,500 192,000 (192,000) 243,500Dividends declared 30,000 24,000 (a) (24,000)+ 30,000Retained earnings, end of year 213,500 168,000 (168,000) 213,500


35




Balance/Assets Palm Corporation

Starr Company


Consolidated

Cash 15,900 72,100 88,000

Intercomapny receivable (payable) 24,000 (24,000)Inventories 136,000 115,000 251,000

Other current assets 88,000 131,000 219,000

Investment in Starr Company common stock 505,500 (a) (505,500)Plant assets (net) 3,500,000 340,000 (a) 61,000 841,000Patent (net) 440,000 16,000 (a) 4,000 20,000Goodwill (net) (a) 14,500 14,500

Total assets 1,209,400 650,100 (426,000) 1,433,,500


36



For Year Ended December 31,2000Liabilities

&Stockholders’ EquityPalm

CorporationStarr

CompanyEliminations


Income taxes payable 40,000 20,000 60,000

Other liabilities 190,900 204,100 395,000

Common stock,$10par 400,000 400,000

Common stock, $5 par 200,000 (a) (200,000)

Additional paid-in capital 365,000 58,000 (a) (58,000) 365,000Retained earnings 213,500 168,000 (168,000) 213,500 Total liabilities & stockholders’ equity 1,209,400 650,000 (426,000) 1,433,500


37

Equity Method: Wholly Owned Subsidiary Subsequent to Date of Purchase-type Business Combination (contd.) Note:

1. The intercompany receivable and payable, placed in adjacent columns on the same line, are offset without a formal elimination.

2. The FIFO method s used by Starr; thus, the $25,000 difference attributable to the beginning inventories of Starr is allocated to the cost of goods sold for year 2000.


38


3. The step up (current fair value excess on Starr’s net assets) is only included in the consolidated balance sheet for the unamortized balance. Step- up on land is

not subject to amortization.


39


4. The use of equity method results in:Parent company net income =

consolidated net incomeParent company retained earnings =

consolidated retained earnings

These equalities exist when the equity method is used and no intercompany profits accounted for in the

determination of consolidated net assets.


40


5. Consolidated financial statements provide more information than those of the parent company despite the equalities in the net income and retained earnings.

6. The retained earnings of Palm on 12/31/2000 includes only $29,500 share of the subsidiary’s adjusted net income for the year ended 12/31/2000.


41

Consolidated Financial Statements

The consolidated income statement, statement of retained earnings and balance sheet of Palm corp. and subsidiary for the year ended December 31, 2000 are as follows: (on p294 and 295 of textbook)


42

Consolidated Financial Statements (contd.)

PALM CORPORATION AND SUBSIDIARYConsolidated Income Statement

For Year Ended December 31,2000Net Sales $1,780,000

Costs and expenses:

Costs and goods sold $1,179,000

Operating expenses 349,167

Interest expense 49,000

Income taxes expense 93,333

Total costs and expenses

1,670,000

Net income $109,500

Basic earnings per share of common stock (40,000 shares outstanding) $ 2.74


43


PALM CORPORATION AND SUBSIDIARYConsolidated Statement of Retained Earnings


Retained earnings, beginning of year: $ 134,000Add: Net income 109,500

Subtotals $ 243,500

Less: Dividends($0.75 a share) 30,000

Retained earnings, end of year $ 213,500


44


PALM CORPORATION AND SUBSIDIARYConsolidated Balance Sheet

For Year Ended December 31,2000Assets

Current assets:

Cash $ 88,000

Inventories 251,000

Other 219,000

Total current assets $ 558,000

Plant assets (net) 841,000

Intangible assets:

Patent(net) $20,000

Goodwill (net) 14,500 34,500Total assets $1,433,500


45


PALM CORPORATION AND SUBSIDIARYConsolidated Balance Sheet

For Year Ended December 31,2000Liabilities $ Stockholders’ Equity

Liabilities:

Income taxes payable $ 60,000

Other 395,000

Total liabilities $ 455,000

Stockholders’ equity:

Common stock, $10 par $ 400,000

Additional paid-in capital 365,000

Retained earnings 213,500 978,500Total Liabilities&

stockholders’ equity $1,433,500


46

Closing Entries

Closing entries should be prepared for both the parent company and the subsidiary at the end of the fiscal year after the financial statements[1] being prepared. The closing entries for the subsidiary are prepared in the usual fashion. The closing entries for the parent company are prepared in the usual fashion except for the closing of the income summary to the retained earnings. Palm Corporation prepares the closing entries on 12/31/2000, after the consolidated financial statements have been prepared, as follows:


47

Closing Entries (contd.)

[1] Consolidated financial statements for the parent company and the regular F/S for the subsidiary.The parent and subsidiary are two separate legal entities. When consolidated F/S are prepared using the equity method, the economic substance of the parent-subsidiary relationship is being emphasized rather than their legal form.


48


Net Sales

Intercompany Investment Income 1,100,000

Income Summary 29,500

Income Summary 1,020,000

Cost of Goods Sold 700,000

Operating Expense 217,667

Interest Expense 49,000

Income Taxes Expense 53,333


49


Income Summary 109,500

Retained Earnings of Subsidiary 5,500Retained Earnings b 104,000

Retained Earnings 30,000

Dividends Declared 30,000


50


a.The portion of retained earnings which is contributed by the subsidiary. The computation is $29,500 (adjusted net income of subsidiary) – 24,000 (dividends declared by the subsidiary). This amount of retained earnings is NOT available for dividends to Palm’s stockholders.

b.The portion of retained earnings which is contributed by the operation of the parent company.


51

Closing Entries (contd.) After the foregoing closing entries, the

balances of Palm Corp.’s Retained Earnings and Retained Earnings of subsidiary ledger accounts are as follows:

Retained Earnings134,000 Beg.Balance104,500 Close net income

available for dividends to stockholders of Palm

Close dividends declared

30,000

208,000


52


Retained Earnings of Subsidiary5,500 Close net income not

available for dividends to


53


The balance of the retained earnings of subsidiary is equal to the net increase in the balance of Palm’s investment in Starr Company Stock account as shown below:

$505,500 ( the balance of the Investment account on 12/31/2000)

- 500,000 ( the balance of the Investment account on 12/31/99)

$5,500


54

Example of Equity Method for Wholly Owned Purchased Subsidiary for Second Year After Business Combination (textbook p297-300) The Palm-Starr example is continued to be

used to illustrate the application of the equity method for a wholly owned purchased subsidiary for the second year after a business combination. On December 17, 2001, Starr declared a dividend of $40,000, payable January 6, 2002, to Palm Corp., the stockholder of record on December 28,2001. For the year ended 12/31/2001, Starr had a net income of $90,000.


55

Example of Equity Method for Wholly Owned Purchased Subsidiary for Second Year After Business Combination (contd.) After the posting of appropriate journal

entries for 2001 under the equity method, selected ledger accounts for Palm Corp. are as follows:

Investment in Starr’s Common Stock12/31/99 450,000 a

12/31/99 50,000 b

12/31/00 60,000 d 24,000 c 12/20/0030,500 e 12/31/00

12/31/01 90,000 f 40,000 g 12/17/015,500 h 12/31/01

12/31/00 505,000


56

Example of Equity Method for Wholly Owned Purchased Subsidiary for Second Year After Business Combination (contd.)a.Issuance of common stock (by Palm) in the

acquisition of Starr.b.Direct out-of-pocket costs of business

combination.c.Recognition of dividend declared by the

subsidiary-Starr for year 2000.d.Recognition of wholly owned subsidiary’s

(Starr) net income for 2000.e.Recog. of depre. and amor. on the step-up

of Starr’s net assets for 2000.


57

Example of Equity Method for Wholly Owned Purchased Subsidiary for Second Year After Business Combination (contd.)

Intercompany Investment Income60,000 a 12/20/00

12/31/00 30,500 b

12/31/00 29,500 d 29,500 c 12/21/000 12/31/00

90,000 e 12/31/01

12/31/00 5,500 f

84,500 12/31/01


58

Example of Equity Method for Wholly Owned Purchased Subsidiary for Second Year After Business Combination (contd.)a. Palm Corp.’s share in the net income of Starr for

the year ended 12/31/00b. The adjustment for the amort. and depre. of step-

up in net assets of Starr for year 2000.c. Palm Corp.’s share in the adjusted net income of

Starr.d. Closing entry prepared on 12/31/00 to close the

intercompany Investment income balance to zero.e. Plam Corp’s share in the net income of Starr for

the year ended 12/31/01.f. The adjustment for the amort. and derp. of step-up

in net assets of Starr for the year of 2001.


59

Developing the Elimination for the Second Year Subsequent to the Business Combination The working paper elimination for December

31, 2001, is similar to that for December 31, 2000, as follows:Common Stock-Starr 200,000

Additional Paid-in Capital – Starr 58,000Retained Earnings-Starr 162,000 a

Retained Earnings of Subsidiary-Palm 5,500Investment Income-Palm 84,500

Plant Assets (net)-Starr ($61,000-4,000) 57,000


60

Developing the Elimination for the Second Year Subsequent to the Business Combination (contd.)Patent (net)- Starr ($4,000-1,000) 3,000Goodwill (net)- Starr ($14,500-500) 14,000Cost of Goods Sold-Starr 4,000 b

Operating Expense-Starr 1,500 b

Investment in Starr Common Stock 550,000Dividends Declared-Starr 24,000

a. 168,000-5,500


61

Developing the Elimination for the Second Year Subsequent to the Business Combination (contd.)b.The depre. and amor. on differences

between current fair value and carrying amount of Starr’s net assets for year 2001 are as follows:

Cost of Goods Sold

Operating Exp.

Building Depre. $1,000 $1,000Machinery Depre. 2,000

Patent Amort. 1,000

Goodwill Amort. 500

Totals $4,000 $1,500


62

Working Paper for Consolidated Financial Statement for the Second Year following the Business Combination (Equity Method: Wholly Owned Purchase-Type Business Combination)

The following is a partial working paper for consolidated financial statement. The net income and dividends for Palm Corp. are assumed.(on textbook p299)


63


PALM CORPORATION AND SUBSIDIARYPartial Working paper for Consolidated Financial Statements


(Continued)


Palm Corporation

Starr Company


Consolidated

Retained earnings, beginning of year 208,000 168,000 (a) (162,500) 213,500Net income 244,500 90,000 (90,000)* 244,500

Subtotal 452,500 258,000 (252,500) 458,000Dividends declared 60,000 40,000 (a) (40,000)+ 60,000Retained earnings, end of year 392,500 218,000 (212,500) 398,000* Decrease in intercompany investment income($84,500), plus total increase

in costs and expenses ($4,000 +$1,500), equals $90,000.+ A decrease in dividends and an increase in retained earnings.


64


PALM CORPORATION AND SUBSIDIARYPartial Working paper for Consolidated Financial Statements

For Year Ended December 31,2001Balance Sheet Palm

CorporationStarr

CompanyEliminations


Common Stock, $10 par 400,000 400,000Common Stock, $5 par 200,000 (a)(200,000)

Additional paid-in capital 365,000 58,000 (a) (58,000) 365,000Retained earnings 392,500 208,000 (212,500) 398,000Retained earnings of subsidiary 5,500 1,163,000 (a) (5,500) Total stockholders’ equity 1,163,000 476,000 (476,000) 1,163,000Total liabilities & stockholders’ equity x,xxx,xxx xxx,xxx (476,000) x,xxx,xxx


65

Closing Entries

The closing entries for Palm is prepared in the usual way except for the closing of the income summary to retained earnings. As in the first year, the portion of retained earnings contributed by Starr should be reported separated from other retained earnings contributed by Plam. The closing entries pertaining the income summary are as follows:Income Summary 244,500

Retained Earnings of Subsidiaries a

44,500

Retained Earnings b 200,000


66


a.The portion of retained earnings contributed by the subsidiary and is not available for dividends to Palm’s stockholders. The computation is as follows:$ 84,500…the adjusted net income of Starr- 40,000…declared dividend by Starr $ 44,500

b.the portion of retained earnings contributed by Palm ($244,500 – 44,500)


67


Thus, the parent company’s ledger accounts for retained earnings are as follows after the closing entries:

Retained Earnings134,000 Bal. On 12/31/99

104,000 R/E contributed by Palm in Year 2002

Div. of 2000 30,000

200,000 R/E contributed by Palm in Year 2001

Div. of 2001 60,000

348,000 Bal. On 12/31/2001


68


Retained Earnings of Subsidiary5,500 R/E contributed by Starr

in year 2000, not available for dividends.

44,500 R/E contributed by Starr in year 2001, not available for dividends.

50,000 Bal. On 12/31/2001


69

Accounting for Operating Results of Partially Owned Purchased Subsidiaries

The minority interest in net income (or net losses) needs to be computed and reported in the consolidated income statement (of a parent company and its partially owned purchased subsidiary) as an expense: minority interest in income (or loss) of subsidiary. In the balance sheet statement, the minority interest in net assets of subsidiary is reported as a liability.


70

Example 7.3: Equity Method for Partially Owned Purchased Subsidiary for First Year after Business Combination Continued with the Post Corporation-

Sage Company consolidated equity example of Chapter 6 (Example 6.2 in the PowerPoint notes and pages 244 to 245 of the textbook), assume that Sage Company declared a $1 a share dividend on 11/24/2000, payable 12/16/2000 to stockholders of record 12/1/2000. Also, Sage had a net income of $90,000 for the year-ended 12/31/2000 (note: Post owns 95% of the outstanding shares).


71

Example 7.3: Equity Method for Partially Owned Purchased Subsidiary for First Year after Business Combination (contd.) Sage’s journal entries pertaining the

declaration and payment of the dividend are as follows:

Journal Entries for Sage (Year 2000)11/24 Dividends Declared (40,000 x $1) 40,000

Dividends Payable ($40,000 x 0.05) 2,000Intercompany Dividends Payable ($40,000 x 0.95) 38,000

To record declaration of dividend payable Dec. 16,2000, to stockholders of record Dec. 1,2000


72

Example 7.3: Equity Method for Partially Owned Purchased Subsidiary for First Year after Business Combination (contd.) Journal Entries for Sage(Year 2000) (contd.)

12/16 Dividends Payable 2,000

Intercompany Dividends Payable 38,000

Cash 40,000To record payment of dividend declared Nov. 24,2000, to stockholders of record Dec. 1,2000


73

Example 7.3: Equity Method for Partially Owned Purchased Subsidiary for First Year after Business Combination (contd.) Following the equity method, Post’s journal

entries for year 2000 include the following: Journal Entries for Post (Year 2000)

11/24 Intercompany Dividends Receivable

38,000

Investment in Sage Company Common Stock

38,000

To record dividend declared by Sage Company, payable Dec. 16, 2000, to stockholders of record Dec. 1,2000.


74

Example 7.3: Equity Method for Partially Owned Purchased Subsidiary for First Year after Business Combination (contd.) Journal Entries for Post(Year 2000) (contd.)

12/16 Cash 2,000

Intercompany Dividends Receivable 38,000

To record receipt of dividend from Sage Company

12/31 Investment in Sage Company Common Stock ($90,000 x 0.95) 85,500

Intercompany Investment Income 85,500

To record 95% of net income of Sage Company for the year ended Dec. 31,2000(Income tax effects are disregarded.)


75

Example 7.3: Equity Method for Partially Owned Purchased Subsidiary for First Year after Business Combination (contd.) Similar to the adjustment on the wholly

owned subsidiary’s net income, the net income of the partially owned subsidiary also needs to be adjusted for the depreciation of the assets step-up ($246,000, see p64 of chapter 6 notes) and the amortization of goodwill ($38,000, see p68 of chapter 6 notes). The assets step-up for Sage on 12/31/99 is as follows:


76

Example 7.3: Equity Method for Partially Owned Purchased Subsidiary for First Year after Business Combination (contd.)Inventories(FIFO cost) $ 26,000

Plant assets (net):

Land $ 60,000

Building (economic life 20 years) 80,000 Machinery (economic life 5 years) 50,000 190,000Leasehold (economic life 6 years) 30,000

Total $246,000


77

Example 7.3: Equity Method for Partially Owned Purchased Subsidiary for First Year after Business Combination (contd.) The goodwill of for the purchase of 95%

of Sage is calculated as follows:Cost of Post Corporation’s 95% interest in Sage Company $1,192,250Less:95% of $1,215,000 aggregate current fair values of Sage’s identifiable net assets 1,154,250Goodwill acquired by Post (to be amortized over 40 years) $ 38,000


78

Example 7.3: Equity Method for Partially Owned Purchased Subsidiary for First Year after Business Combination (contd.) Therefore, Post Corp. prepares the following

journal entry on 12/31/2000 to reflect the effects of the depreciation on the assets step-up under the equity method:

Journal Entry for Post (12/31/2000)


Investment in Sage Company Common Stock 42,750


79

Example 7.3: Equity Method for Partially Owned Purchased Subsidiary for First Year after Business Combination (contd.) To amortize differences between current fair

values and carrying amounts of Sage Company’s identifiable net assets on Dec. 31,1999, as follows:

Inventories– to cost of goods sold $26,000Building—depreciation ($80,000/20) 4,000Machinery—depreciation ($50,000/5) 10,000

Leasehold—amortization ($30,000/6) 5,000

Total difference applicable to 2000 $45,000

Amortization for 2000($45,000 x 0.95) $42,750(Income tax effects are disregarded.)


80

Example 7.3: Equity Method for Partially Owned Purchased Subsidiary for First Year after Business Combination (contd.) In addition, Post also prepares the following

entry to recognize the amortization of goodwill:

Journal Entry for Post (12/31/2000)

Amortization Expense ($38,000/40) 950

Investment in Sage Company Common Stock 950

To amortize goodwill acquired in business combination with partially owned purchased subsidiary over an economic life of 40 years.


81

Example 7.3: Equity Method for Partially Owned Purchased Subsidiary for First Year after Business Combination (contd.) Note: goodwill in a business

combination involving partially owned subsidiary is attributed to the parent company rather than the subsidiary under the FASB recommended treatment. This technique avoids charging any portion of the goodwill amortization to the minority interest, which did not acquire any goodwill.


82

Example 7.3: Equity Method for Partially Owned Purchased Subsidiary for First Year after Business Combination (contd.) After posing the foregoing entries,

Post Corporation’s Investment in Sage Company Common Stock and Intercompany Investment Income ledger accounts are as follows:


83

Example 7.3: Equity Method for Partially Owned Purchased Subsidiary for First Year after Business Combination (contd.)

Investment in Sage Company Common StockDate Explanation Debit Credit Balance

199912/31 Issuance of common stock

in business combination 1,140,000 1,140,000 dr 31 Direct out-of-pocket costs of

business combination 52,250 1,192,250 dr200011/24 Dividend declared by Sage 38,000 1,154,250 dr12/31 Net income of Sage 85,500 1,239,750 dr 31 Amortization of differences

between current fair values and carrying amounts of Sage’s identifiable net assets 42,750 1,197,000 dr

31 Amortization of goodwill 500 1,196,050 dr


84

Example 7.3: Equity Method for Partially Owned Purchased Subsidiary for First Year after Business Combination (contd.)

Intercompany Investment IncomeDate Explanation Debit Credit Balance200012/31 Net Income of Sage 85,500 85,500 cr 31 Amortization of

differences between current fair values and carrying amounts of Sage’s identifiable net assets 42,750 42,750 cr


85

Example 7.3: Equity Method for Partially Owned Purchased Subsidiary for First Year after Business Combination (contd.) The $42,750 balance of Post

corporation’s Intercompany Investment Income account represents 95% of the $45,000 adjusted net income ($90,000-$45,000) of Sage Company for the year ended 12/31/2000.


86

Developing the elimination for Example 7.3 Using the equity method to account for

the investment in Sage results in a balance in the Investment ledger account with three components:(1) the carrying amount of Sage’s identifiable net assets;(2)the “current fair value excess” , which is attributable to Sage’s identifiable net assets; and (3) the goodwill acquired by Post in the business combination with Sage. These components are analyzed as follows:


87

Developing the elimination for Example 7.3 (contd.)

Post CorporationAnalysis of Investment in Sage Company Common Stock

Ledger Account (For Year Ended December 31,2000)Carrying Amount

Current Fair Value

Excess

Goodwill Total

Beginning balances $920,550 $233,700 $38,000 $1,192,250Net income of Sage ($90,000 x 0.95) 85,500 85,500Amortization of differences between current fair values and carrying amounts of Sage’s identifiable net assets ($45,000 x 0.95) (42,750) (42,750)


88

Developing the elimination for Example 7.3 (contd.) Contd.

Carrying Amount

Current Fair Value

Excess

Goodwill Total

Amortization of goodwill (950) (950)Dividend declared by Sage ($40,000 x 0.95) (38,000) (38,000)Ending balances $968,050 $190,950 $37,050 $1,196,050


89

Developing the elimination for Example 7.3 (contd.) The minority interest in Sage’s net

assets (which is not recorded in a ledger account) is analyzed similarly, except that there is not goodwill attributable to the minority interest:


90


Post CorporationAnalysis of Minority Interest in Net Assets of Sage Company

For Year Ended December 31,2000Carrying Amount

Current Fair Value

Excess

Total

Beginning balances $48,450 $12,300 $60,750Net income of Sage($90,000 x 0.05) 4,500 4,500Amortization of differences between current fair values and carrying amounts of Sage’s identifiable net assets ($45,000 x 0.05) (2,250) (2,250)Dividend declared by Sage ($40,000 x 0.05) (2,000) (2,000)Ending balances $50,950 $10,050 $61,000


91


Carrying Amount

Current Fair Value

Excess

Goodwill Total

Amortization of goodwill (950) (950)Dividend declared by Sage ($40,000 x 0.95) (38,000) (38,000)Ending balances $968,050 $190,950 $37,050 $1,196,050


92

Developing the elimination for Example 7.3 (contd.) The sum of the ending balances of the

carrying amount columns of the above two tables equals $1,019,000 ($968,050 +$50,950).This amount agrees with the total stockholders’ equity of Sage Company on 12/31/2000 as follows:

Common stock,$10 par $ 400,000Additional paid-in capital 235,000Retained earnings 384,000

Total stockholders’ equity $1,019,000


93

Developing the elimination for Example 7.3 (contd.) Also, the sum of the ending balances of

the carrying fair value excess columns of the above two tables equals $201,000 ($190,950 +$10,050). This amount represents the unamortized identifiable assets step-up as follows:


94


Balances,Dec.31,1999

(p.302)

Amortization for Year 2000

(p.302)

Balances,Dec.31,2000

Inventories $ 26,000 $ (26,000)Plant assets(net): Land $ 60,000 $ 60,000 Building 80,000 $ (4,000) 76,000 Machinery 50,000 (10,000) 40,000

Total plant assets $190,000 $ (14,000) $176,000

Leasehold $ 30,000 $ (5,000) $ 25,000Totals $246,000 $ (45,000) $201,000


95

Developing the elimination for Example 7.3 (contd.) Assuming that Sage Company

allocates machinery depreciation and leasehold amortization entirely to cost of goods sold and building depreciation 50% each to cost of goods sold and operating expense, the working paper eliminations for Post Corp. and subsidiary on 12/31/200 are as follows:


96


POST CORPORATION AND SUBSIDIARYWorking Paper Eliminations

December 31,2000

(a)Common Stock–Sage 400,000(1)

Additional Paid-in Capital–Sage 235,000(1)

Retained Earnings-Sage 334,000(1)

Intercompany Investment Income-Psot 42,750(2)

Plant Assets(net)-Sage($190,000-$14,000) 176,000(3)

Leasehold(net)-Sage ($30,000-$5,000) 25,000(3)

Goodwill (net)-Post($38,000-$950) 37,050(3)

Cost of Goods Sold-Sage 43,000(4)

Operating Expenses-Sage 2,000(4)


97


Investment in Sage Company Common Stock-Post 1,196,050(1)Dividends Declared-Sage 40,000(1)

Minority Interest in Net Assets of Subsidiary ($60,750 - $2,000)[See(d)] 58,750(1)


98

Developing the elimination for Example 7.3 (contd.) To carry out the following:

(a) Eliminate intercompany investment and equity accounts of subsidiary at the beginning of year, and subsidiary

dividends.

(b) Provide for Year 2000 depreciation and amortization on differences between current fair values and carrying

amounts of Sage’s identifiable net assets as follows:


99


Cost of Goods Sold

Operating Expenses

Inventories sold $ 26,000

Building depreciation 2,000 $ 2,000

Machinery depreciation 10,000

Leasehold amortization 5,000

Totals $ 43,000 $ 2,000


100


(c) Allocate unamortized differences between combination date current fair values and carrying amounts to appropriate assets.(d) Establish minority interest in net assets of subsidiary at beginning of year ($60,750), less minority interest share of dividends declared by subsidiary during year ($40,000 x 0.05=$2,000).(Income tax effects are disregarded.)


101


(b)Minority Interest in Net Income of Subsidiary 2,250

Minority Interest in Net Assets of Subsidiary

2,250


102

Developing the elimination for Example 7.3 (contd.) To establish minority interest in subsidiary’s

adjusted net income for Year 2000 as follows: Net income of subsidiary $ 90,000 Net reduction of elimination (a) ($43,000 +$2,000) (45,000) Adjuste net income of subsidiary $45,000 Minority interest share ($45,000 x 0.05) $ 2,250

Notes: (on textbook p305)


103

Working Paper for Example 7.3: Consolidated Financial Statements for year Ended 12/31/2000

POST CORPORATION AND SUBSIDIARYWorking Paper for Consolidated Financial Statements

For Year Ended Dec. 31,2000Income Statement Post

Corp.Sage

CompanyEliminations

Inc. (Dec.)Consolidated

Revenue:

Net Sales 5,611,000 1,089,000 6,700,000

Intercompany investment income 42,750 (a) (42,750)

Total revenue 5,653,750 1,089,000 (42,750) 6,700,000Costs and expenses:

Costs of goods sold 3,925,000 700,000 (a) 43,000 4,668,000 Operating expenses 556,950* 129,000 (a) 2,000 687,950 Interest and income taxes expense 710,000 170,000 880,000 Minority interest in net income of subsidiary (b) 2,250 2,250

Total costs and expenses 5,191,950 999,000 47,250 † 6,238,200Net Income 461,800 90,000 (90,000) 461,800


104

Working Paper for Example 7.3: Consolidated Financial Statements for year Ended 12/31/2000 (contd.) Contd.


Post Corp.

Sage Company

Eliminations Inc. (Dec.)

Consolidated

Retained earnings, beginning of year 1,050,000 334,000 (a) (334,000) 1,050,000Net income 461,800 90,000 (90,000) 461,800 Subtotal 1,511,800 424,000 (424,000) 1,511,800Dividends declared 158,550 40,000 (a) (40,000)‡ 158,550Retained earnings, end of year 1,353,250 384,000 (384,000) 1,353,250


105

Working Paper for Example 7.3: Consolidated Financial Statements for year Ended 12/31/2000 (contd.) Contd.Balance Sheet/

AssetsPost Corp.

Sage Company


Consolidated

Inventories 861,000 439,000 1,300,000Other current assets 639,000 371,000 1,010,000Investment in Sage Company common stock 1,196,050 (a)(1,196,050)Plant assets (net) 3,600,000 1,150,000 (a) 176,000 4,926,000Leasehold (net) (a) 25,000 25,000Goodwill (net) 95,000 (a) 37,050 132,050

Total assets 6,391,050 1,960,000 (958,000) 7,393,050


106

Working Paper for Example 7.3: Consolidated Financial Statements for year Ended 12/31/2000 (contd.) Contd.

Liabilities &Stockholders’ Equity

Post Corp.

Sage Company


Consolidated

Liabilities 2,420,550 941,000 3,361,550

Minority interest in net assets of subsidiary (a) 58,750

(b) 2,250 61,000Common stock,$1 par 1,057,000 1,057,000

Common stock, $10 par 400,000 (a) (400,000)

Additional paid-in capital 1,560,250 235,000 (a) (235,000) 1,560,250Retained earnings 1,353,250 384,000 (384,000) 1,353,250 Total liabilities & stockholders’ equity 6,391,050 1,960,000 (958,000) 7,393,050


107

Consolidated Financial Statements for Example 7.3 The consolidated income statement,

statement of retained earnings, and balance sheet of Post Corporation and subsidiary for the year ended December 31, 2000, are as follows (the amounts are from the consolidated column in the previous working paper):


108

Consolidated Financial Statements for Example 7.3 (contd.)

POST CORPORATION AND SUBSIDIARYConsolidated Income Statement

For Year Ended December 31,2000Net Sales $ 6,700,000

Costs and expenses:

Costs and goods sold $4,668,000

Operating expenses 687,950

Interest and income taxes expense

880,000

Minority interest in net income of subsidiary 2,250

Total costs and expenses 6,238,200

Net income $ 461,800

Basic earnings per share of common stock(1,057,000 shares outstanding) $ 0.44


109


POST CORPORATION AND SUBSIDIARYConsolidated Statement of Retained Earnings


Retained earnings, beginning of year: $ 1,050,000Add: Net income 461,800

Subtotals $1,511,800

Less: Dividends ($0.15 a share) 158,550

Retained earnings, end of year $ 1,353,250


110


POST CORPORATION AND SUBSIDIARYConsolidated Balance Sheet

For Year Ended December 31,2000Assets

Current assets:

Inventories $ 1,300,000

Other 1,010,000

Total current assets $ 2,310,000

Plant assets (net) 4,926,000

Intangible assets:

Leasehold (net) $ 25,000

Goodwill (net) 132,050 157,050Total assets $7,393,050


111

Consolidated Financial Statements for Example 7.3 (contd.) Contd.

Liabilities & Stockholders’ EquityLiabilities

Other than minority interest $3,361,550 Minority interest in net assets of subsidiary 61,000

Total liabilities $3,422,550

Stockholder’s equity:

Common stock, $1 par $1,057,000

Additional paid-in capital 1,560,250

Retained earnings 1,353,250 3,970,500Total liabilities & stockholders’ equity $7,393,050


112

Closing Entries for Example 7.3

Post Corporation Closing Entries on 12/31/2000

Net Sales 5,611,000


Income Summary 5,653,750To close revenue accounts.

Income Summary 5,191,950

Cost of Goods Sold 3,925,000

Operating Expenses 556,950

Interest and Income Taxes Expense 710,000

To close expense accounts.


113

Closing Entries for Example 7.3 (contd.)

Contd.Income Summary 461,800

Retained Earnings of Subsidiary ($42,750-$38,000) 4,750Retained Earnings ($461,800-$4,750)

457,050

To close Income Summary account; to transfer net income legally available for dividends to retained earnings; and to segregate 95% share of adjusted net income of subsidiary not distributed as dividends.

Retained Earnings 158,550

Dividends Declared 158,550To close Dividends Declared account.


114


After posting the above closing entries, Post’s Retained Earnings and Retained Earnings of Subsidiary ledger accounts are as follows:


115


Date Explanation Debit Credit Balance199912/31 Balance 1,105,000 cr200012/31 Close net income

available for dividends 457,050 1,507,050 cr 31 Close Dividends

Declared account 158,550 1,348,500 cr

Retained Earnings


116


Date Explanation Debit Credit Balance200012/31 Close net income not

available for dividends 4,750 4,750 cr

Retained Earnings of Subsidiary

acct 501 by professor hsieh chapter consolidated financial statements: subsequent to date of...

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