chapter consolidated statements: subsequent to acquisition fundamentals of advanced accounting 1 th...

CHAPTER

Consolidated Statements:Subsequent to Acquisition

Fundamentals of Advanced Accounting 1th Edition

Fischer, Taylor, and Cheng

33

Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 3, Slide #2

Consolidated Statements Subsequent to Acquisition

Two basic methods to maintain the parent’s investment account:

• Equity Method (Simple & Sophisticated)

• Cost Method


Equity Method of Accounting for Investments

• Equity Method: Parent records income when subsidiary reports income

– Parent used percent of ownership time sub’s net income to record investment income

– Dividends treated as return of investment – investment account is reduced

– Sophisticated Equity Method recognizes amortization on the parent’s ledger for the difference from book value to fair value.


Cost Method of Accounting for Investments

Cost Method: Parent records income when subsidiary declares dividends

• Most commonly used method

• No adjustments to investment account


Example – Company P and Subsidiary Company S

• Parent purchases 90% of Sub’s stock for $145,000.

• Sub has equity accounts:

Common Stock $100,000

Retained Earnings 50,000• 20X1 – Sub:

Net Income = $30,000, Dividends = $10,000• 20X2 – Sub:

Net Loss = ($10,000), Dividends = $5,000


D&D Schedule Example – Company P and Subsidiary Company S

Price paid: $ 145,000

Interest acquired:

Common stock $ 100,000

Retained earnings 50,000

Total equity 150,000

Ownership interest × 90% 135,000Excess cost 10,000

Annual Life Amort.

Patent …………………………… $10,000 10 $1,000


Parent Recording of Subsidiary Income (Year 1)

Equity Sophisticated

Equity Cost Investment balance 145,000 145,000 145,000

Year 1 income (90%): Investment in Sub Investment income

27,000

27,000

26,000

26,000 (1,000 amort.)

no entry

Year 1 dividends(90%): Dividend receivable Investment in Sub Dividend income

9,000

9000

9,000

9,000

9,000

9,000 Investment balance 163,000 162,000 145,000


Parent Recording of Subsidiary Income (Year 2)

Equity Sophisticated

Equity Cost Investment balance 163,000 162,000 145,000

Year 2 income (90%): Investment Loss Investment in Sub

9,000

9,000

10,000

10,000 (1,000 amort.)

no entry

Year 2 dividends (90%): Dividend receivable Investment in Sub Dividend income

4,500

4,500

4,500

4,500

4,500

4,500 Investment balance 149,500 147,500 145,000


Worksheet Procedures

• The RE of the Sub and the Investment account must be at the same point in time– Eliminate entries during the year to complete alignment

• When adjusted to the same point in time, the excess upon elimination will agree with the D&D on purchase date – Sophisticated Equity results in only the amortized balance

of the excess

• The account adjustments made require amortization for current and prior periods– No entries are made on either firm’s books for worksheet

eliminations


Worksheet Elimination Procedures

Key Description Simple Equity

Soph. Equity Cost

CV Convert to Equity CY1 Eliminate Sub Income

CY2 Eliminate intercompany dividends EL Eliminate parent’s % of sub equity D Distribute excess per D&D

schedule

A Amortize excess


Worksheet Elimination Entries – Simple Equity

CY1 Sub Income - Par 27,000

Invest. In Sub - Par 27,000(Eliminates current year income and creates date alignment)

CY2 Invest. In Sub - Par 9,000

Dividends Declared - Sub 9,000(Eliminates intercompany dividends)

EL Common Stock - Sub 90,000

Retained Earnings - Sub 45,000

Invest. In Sub - Par 135,000(Eliminates investment account against 90% of equity)


Worksheet Elimination Entries – Simple Equity Continued

D Patent 10,000

Invest. In Sub - Par 10,000(Eliminates balance of investment account and distributes to

proper accounts)

A Patent Amort. Expense 1,000

Patent 1,000(Amortized excess cost of the patent over its 10 year life)


Simple Equity: Worksheet 3-1 Year 1

Selected Accounts Trial Balances Eliminations Parent Sub Dr Cr Investment in Sub 163,000 CY2 9,000 CY1 27,000

EL 135,000 D 10,000

Patent D 10,000 A 1,000 Other net assets 227,000 170,000 Com. Stock – Par (200,000) RE – Parent (123,000) Com. stock – Sub (100,000) EL 90,000 RE – Sub (50,000) EL 45,000 Revenue (100,000) (80,000) Expenses 60,000 50,000 Patent Amort. A 1,000 Subsidiary Income (27,000) CY1 27,000 Dividends declared 10,000 CY2 9,000


Review of Worksheet Procedures

• Elimination of equity income and intercompany dividends returns investment to Jan. 1 for date alignment

• Excess is distributed per D&D; amortized for current and prior years

• IDS (income distribution schedule) is used to allocate income to P & S– All excess amortizations go to P; only P’s share

is recorded initially


Features of Consolidated Statements

• Consolidated net income is total income earned by the entity.– Consolidated net income is distributed to:

• Parent• Non-Controlling interest

• Retained Earnings statement– Shows only controlling interest

• Consolidated Balance Sheet reports NCI as subdivision of equity


Worksheet Elimination Entries – Cost Method

CY2 Dividend Income - Par 9,000Dividends Declared - Sub 9,000

(Eliminates intercompany dividends)

EL Common Stock - Sub 90,000 Retained Earnings - Sub 45,000


D Patent 10,000Invest. In Sub - Par 10,000

(Eliminates balance of investment account and distributes to proper accounts)

A Patent Amort. Expense 1,000Patent 1,000

(Amortized excess cost of the patent over its 10 year life)


Cost Method: Worksheet 3-3 Year 1

Selected Accounts Trial Balances Eliminations Parent Sub Dr Cr Investment in Sub 145,000 EL 135,000

D 10,000 Patent D 10,000 A 1,000 Other net assets 227,000 170,000 Com. Stock – Par (200,000) RE – Parent (123,000) Com. stock – Sub (100,000) EL 90,000 RE – Sub (50,000) EL 45,000 Revenue (100,000) (80,000) Expenses 60,000 50,000 Patent Amort. A 1,000 Subsidiary Income (9,000) CY2 9,000 Dividends declared 10,000 CY2 9,000


Subsequent years – Cost Method

• For periods after the first year, date alignment will not exist.– Balance of parents investment account ≠ sub’s

retained earnings.

• Calculate simple equity balance for investment account.

• Record entry to adjust investment account.

DR Investment in Sub – Par

CR RE 1/1/20X2 - Par


Effect of Sophisticated Equity Method on Consolidation

• Parent amortizes excess costs of net assets

• Investment account includes only unamortized costs


Worksheet Elimination Entries – Sophisticated Equity Method

CY1 Sub Income - Par 26,000Invest. In Sub - Par 26,000

(Eliminates current year income and creates date alignment)

CY2 Invest. In Sub - Par 9,000Dividends Declared - Sub 9,000

(Eliminates intercompany dividends)

EL Common Stock - Sub 90,000 Retained Earnings - Sub 45,000


D Patent 10,000Invest. In Sub - Par 10,000

(Eliminates balance of investment account and distributes to proper accounts – includes only UNAMORTIZED excess cost)


Sophisticated Equity Method: Year 1

Selected Accounts Trial Balances Eliminations Parent Sub Dr Cr Investment in Sub 162,000 CY2 9,000 CY1 26,000

EL 135,000 D 10,000

Patent D 10,000 A 1,000 Other net assets 227,000 170,000 Com. Stock – Par (200,000) RE – Parent (123,000) Com. stock – Sub (100,000) EL 90,000 RE – Sub (50,000) EL 45,000 Revenue (100,000) (80,000) Expenses 60,000 50,000 Patent Amort. A 1,000 Subsidiary Income (26,000) CY1 26,000 Dividends declared 10,000 CY2 9,000


Disclosure Concerns

• Consolidated net income – The net income of the consolidated entity

• NCI share of income – This is the NCI share of consolidated net income; it has often (incorrectly) been treated as an expense.

• Controlling share of net income – This is the controlling share of consolidated net income; it has often (incorrectly) been treated as consolidated net income (the NCI share having been deducted)

• Total NCI – Best theory is to show as aggregated part of total equity

– Some have shown it as liability or put it between liabilities and equity


During-the-Year Purchases

Option 1 - Close Books (WS 3-7)

• D&D includes Sub RE on purchase date

• WS includes Sub operations for only later part of year

Option 2 - Books Open (WS 3-8)

• D&D has Beginning of year RE and “Purchased Income”

• WS includes Sub operations for entire year

• Purchased income is used to remove income prior to purchase


Goodwill Impairment Losses

• If remaining goodwill is estimated to be less book value of goodwill, record a goodwill impairment loss.

• Impairment loss is reported on consolidated income statement for period in which it occurs.

• Presented before-tax basis.

Two options for impairment losses:• Record loss on parent’s books• Record loss on consolidated worksheet.


Goodwill Impairment Losses - Calculation

Company P purchased 80% interest in Company S in 20X2 resulting in $165,000 of Goodwill.

20X4 information is as follows:Invest in Sub (Soph. Equity) $800,000

Estimated fair value of S. Co. 900,000

Est. fair value of net assets 850,000


Goodwill Impairment Losses - Calculation

• Step one – determine if Goodwill is impaired:Investment in Sub $800,000Fair value of investment 720,000*

*($900,000 total fair value x 80% ownership)

If investment account exceeds fair value, calculate impairment.

• Impairment calculation:Est. fair value of company $900,000Est. fair value of net assets 850,000Est. goodwill 50,000

Parent’s % of goodwill = $50,000 x 80% = $40,000Original goodwill calculation 165,000Goodwill Impairment (125,000)


Tax Issues: Tax-Free Exchange

• Occurs when seller is not taxed; buyer gets book value for future depreciation

• Adjustment from market to book accompanied by DTL = tax % market adjustment

• DTL has same priority as the related asset.

• DTL is amortized over same period as asset adjustment; increases tax liability in future years

• Tax loss carryover is asset recorded in purchase; there are limits on its use in year of purchase and later years

chapter consolidated statements: subsequent to acquisition fundamentals of advanced accounting 1 th...

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