Consolidated Statements Subsequent to Acquisition

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CHAPTER

Consolidated Statements:

Subsequent to Acquisition



Fundamentals of Advanced Accounting

1
th

Edition

Fischer, Taylor, and Cheng

3

3

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

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
3

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.

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
4

Cost Method of Accounting for Investments

Cost Method: Parent records income
when subsidiary declares dividends


Most commonly used method


No adjustments to investment account



Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
5

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


Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
6

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%

135,000



Excess cost


10,000





Annual






Life

Amort.

Patent ……………………………


$10,000

10

$1,000

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
7

Parent Recording of Subsidiary Income
(Year 1)

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
8

Parent Recording of Subsidiary Income
(Year 2)

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
9

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

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
10

Worksheet Elimination Procedures

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
11

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)


Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
12

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)


Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
13

Simple Equity: Worksheet 3
-
1 Year 1

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
14

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

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
15

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

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
16

Worksheet Elimination Entries



Cost Method

CY2


Dividend Income
-

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)

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)

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
17

Cost Method: Worksheet 3
-
3 Year 1

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
18

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

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
19

Effect of Sophisticated Equity Method on
Consolidation


Parent amortizes excess costs of net
assets


Investment account includes only
unamortized costs

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
20

Worksheet Elimination Entries



Sophisticated Equity Method

CY1

Sub Income
-

Par

26,000




Invest. In Sub
-

Par


26,000

(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)

D


Patent

10,000




Invest. In Sub
-

Par


10,000

(Eliminates balance of investment account and distributes to proper accounts


includes only UNAMORTIZED excess cost)

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
21

Sophisticated Equity Method: Year 1

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
22

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

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
23

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

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
24

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.

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
25

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

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
26

Goodwill Impairment Losses
-

Calculation


Step one


determine if Goodwill is impaired:



Investment in Sub

$800,000



Fair 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

$900,000



Est. fair value of net assets

850,000



Est. goodwill

50,000




Parent’s % of goodwill = $50,000 x 80% =

$40,000



Original goodwill calculation

165,000



Goodwill Impairment

(125,000)

Copyright 2008 by Thomson South
-
Western, a part of The Thomson Corporation. All rights reserved.

Chapter 3, Slide #
27

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