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ACCT 501
Chapter 7
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
Consolidated FS-Subsequent to date of purchase type
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Accounting for Operating Results of Wholly Owned Purchased Subsidiaries
A parent company may choose the equity method or the cost method in accounting for the operating results of purchased subsidiaries.
Consolidated FS-Subsequent to date of purchase type
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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 on purchased subsidiary’s net assets.
The parent company also recognizes its share of dividends declared by the subsidiary.
Consolidated FS-Subsequent to date of purchase type
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.
Consolidated FS-Subsequent to date of purchase type
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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.
Consolidated FS-Subsequent to date of purchase type
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Choosing Between Equity Method and Cost Method
Consolidated financial statement amounts are the same regardless of the method used to account for a subsidiary’s operations.
The differences are in the working paper elimination.
Consolidated FS-Subsequent to date of purchase type
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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.
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Example 7.1: Equity Method for holly 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.
Consolidated FS-Subsequent to date of purchase type
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Example 7.1: (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.
Consolidated FS-Subsequent to date of purchase type
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Example 7.1: (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.
Consolidated FS-Subsequent to date of purchase type
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Example 7.1: (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.
Consolidated FS-Subsequent to date of purchase type
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Example 7.1: (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
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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 on Starr’s net assets on 12/31/99.
Consolidated FS-Subsequent to date of purchase type
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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):
Consolidated FS-Subsequent to date of purchase type
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Adjustment of Purchased Subsidiary’s Net Income (contd.)
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
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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
Consolidated FS-Subsequent to date of purchase type
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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)
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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
12/31/00 505,500
Consolidated FS-Subsequent to date of purchase type
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Adjustment of Purchased Subsidiary’s Net Income (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.
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.
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21
Adjustment of Purchased Subsidiary’s Net Income (contd.)
Intercompany Investment Income
60,000 a 12/20/00
12/31/00 30,500 b
29,500
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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 $505,500
Consolidated FS-Subsequent to date of purchase type
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 the balance sheet section of Starr on p293 of textbook):
Consolidated FS-Subsequent to date of purchase type
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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
Consolidated FS-Subsequent to date of purchase type
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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:
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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
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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:
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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 of the subsidiary.
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Palm Corp. and Subsidiary Working Paper Elimination (on 12/31/2000) (contd.)
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:
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Palm Corp. and Subsidiary Working Paper Elimination (on 12/31/2000) (contd.)
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 505,500Dividends Declared-Starr 24,000
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Palm Corp. and Subsidiary Working Paper Elimination (on 12/31/2000) (contd.)
Note:
1. Income tax effects are disregarded
2. the computation of cost of goods sold and operating expense are as follows:
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Palm Corp. and Subsidiary Working Paper Elimination (on 12/31/2000) (contd.)
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
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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
Consolidated FS-Subsequent to date of purchase type
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Equity Method: Wholly Owned Subsidiary Subsequent to Date of Purchase-type Business Combination (contd.)
PALM CORPORATION AND SUBSIDIARYWorking paper for Consolidated Financial Statements
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
Consolidated FS-Subsequent to date of purchase type
35
Equity Method: Wholly Owned Subsidiary Subsequent to Date of Purchase-type Business Combination (contd.)
PALM CORPORATION AND SUBSIDIARYWorking paper for Consolidated Financial Statements
For Year Ended December 31,2000
Balance/Assets Palm Corporation
Starr Company
Eliminations Increase
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
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Equity Method: Wholly Owned Subsidiary Subsequent to Date of Purchase-type Business Combination (contd.)
PALM CORPORATION AND SUBSIDIARYWorking paper for Consolidated Financial Statements
For Year Ended December 31,2000Liabilities
&Stockholders’ EquityPalm
CorporationStarr
CompanyEliminations
IncreaseConsolidated
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
Consolidated FS-Subsequent to date of purchase type
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Equity Method: Wholly Owned Subsidiary Subsequent to Date of Purchase-type Business Combination (contd.) Notes:
1.The intercompany receivable and payable, placed in adjacent columns on the same line, are offset without a formal elimination.
2. The FIFO methods 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.
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Equity Method: Wholly Owned Subsidiary Subsequent to Date of Purchase-type Business Combination (contd.)
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.
4. Step- up on land is not subject to amortization.
Consolidated FS-Subsequent to date of purchase type
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Equity Method: Wholly Owned Subsidiary Subsequent to Date of Purchase-type Business Combination (contd.)
5. The use of equity method results in:Parent company net income = consolidated net income
Parent 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.
Consolidated FS-Subsequent to date of purchase type
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Equity Method: Wholly Owned Subsidiary Subsequent to Date of Purchase-type Business Combination (contd.)
6. Consolidated financial statements provide more information than
those of the parent company despite the equalities in the net income
and retained earnings.
7. 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.
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Consolidated Financial Statements (for example 7.1) 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)
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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
Consolidated FS-Subsequent to date of purchase type
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Consolidated Financial Statements (contd.)
PALM CORPORATION AND SUBSIDIARYConsolidated Statement of Retained Earnings
For Year Ended December 31,2000
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
Consolidated FS-Subsequent to date of purchase type
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Consolidated Financial Statements (contd.)
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
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Consolidated Financial Statements (contd.)
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
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Closing Entries for Example 7.1
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.
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Closing Entries (contd.)
Palm Corporation prepares the closing entries on 12/31/2000, after the consolidated financial statements have been prepared, as follows:
Note: Palm closes its income statement accounts, not the consolidated I/S accounts.
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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.
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Closing Entries (contd.)
Net Sales 1,100,000 Intercompany Invest. Income 29,500
Income Summary 1,129,500
Income Summary 1,020,000
Cost of Goods Sold 700,000
Operating Expense 217,667
Interest Expense 49,000
Income Taxes Expense 53,333
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Closing Entries (contd.)
Income Summary 109,500
Retained Earnings of Subsidiarya 5,500Retained Earnings b 104,000
Retained Earnings 30,000
Dividends Declared 30,000
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Closing Entries (contd.)
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.
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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
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Closing Entries (contd.)
Retained Earnings of Subsidiary5,500 Close net income not
available for dividends to stockholders of Palm
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Closing Entries (contd.)
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
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Example 7.2: 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.
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Example 7.2: 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
12/31/00 550,000
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Example 7.2 :(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.
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Example 7.2 :(contd.)
f.Recognition of wholly owned subsidiary’s (Starr) net income for 2001.
g.Recognition of dividend declared by the subsidiary-Starr for year 2001.
h.Recog. of depre. and amor. on the step-up of Starr’s net assets for 2001.
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Example 7.2: (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
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Example 7.2: (contd.)
a. Palm Corp.’s share in the net income of Starr for the year ended 12/31/00
b. 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.
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Developing the Elimination for the Second Year Subsequent to the Business Combination (Example 7.2) 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
58,000
Retained Earnings-Starr 162,500a
Retained Earnings of Subsidiary-Palm
5,500
Investment Income-Palm 84,500
Plant Assets (net)-Starr ($61,000-4,000)
57,000
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Developing the Elimination for the Second Year Subsequent to the Business Combination (contd.)Patent (net)- Starr ($4,000-1,000)
3,000
Goodwill (net)- Starr ($14,500-500)
14,000
Cost of Goods Sold-Starr 4,000 b
Operating Expense-Starr 1,500 b
Investment in Starr Common Stock 550,000Dividends Declared-Starr 40,000
a. 168,000-5,500
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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
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64
Working Paper for Consolidated Financial Statement for the Second Year following the Business Combination (Equity Method: Wholly Owned Purchase-Type Business Combination)-example 7.2
The following is a partial working paper for consolidated financial statement. The net income and dividends for Palm Corp. are assumed.(on textbook p299)
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65
Working Paper for Consolidated Financial Statement for the Second Year following the Business Combination (Equity Method: Wholly Owned Purchase-Type Business Combination)
PALM CORPORATION AND SUBSIDIARYPartial Working paper for Consolidated Financial Statements
For Year Ended December 31,2001
(Continued)
Statement of Retained Earnings
Palm Corporation
Starr Company
Eliminations Increase
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.
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Working Paper for Consolidated Financial Statement for the Second Year following the Business Combination (Equity Method: Wholly Owned Purchase-Type Business Combination)
PALM CORPORATION AND SUBSIDIARYPartial Working paper for Consolidated Financial Statements
For Year Ended December 31,2001Balance Sheet Palm
CorporationStarr
CompanyEliminations
IncreaseConsolidated
Common Stock, $10 par 400,000 400,000Common Stock, $5 par 200,000 (a)(200,000)
Additional paid-in capital 365,000 58,000 (a) (58,000) 365,000Retained earnings 392,500 218,000 (212,500) 398,000Retained earnings of subsidiary 5,500 (a) (5,500) Total stockholders’ equity 1,163,000 476,000 (476,000) 1,163,000Total liabilities & stockholders’ equity x,xxx,xxx xxx,xxx (476,000) x,xxx,xxx
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Closing Entries for Example 7.2
The closing entries for Palm are prepared in the usual way except for the closing of the income summary to retained earnings.
As in the first year, the portion of retained earnings contributed by Starr should be reported separated from other retained earnings contributed by Plam.
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Closing Entries for Example 7.2 (contd.)
The closing entries pertaining the income summary are as follows:
Income Summary 244,500 Retained Earnings of 44,500
Subsidiaries a
Retained Earnings b 200,000
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Closing Entries (contd.)
a.The portion of retained earnings contributed by the subsidiary and is NOT available for dividends to Palm’s stockholders. The computation is as follows:$ 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)
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70
Closing Entries (contd.)
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
104,500 R/E contributed by Palm in Year 2000
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
Consolidated FS-Subsequent to date of purchase type
71
Closing Entries (contd.)
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
Consolidated FS-Subsequent to date of purchase type
72
Accounting for Operating Results of Partially Owned Purchased Subsidiaries
The minority interest in net income (or net loss) needs to be computed and reported in the consolidated income statement 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.
Consolidated FS-Subsequent to date of purchase type
73
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 6a , assumed that Sage Company declared a $1 a share dividend on 11/24/2000, payable 12/16/2000 to stockholders of record 12/1/2000.
a. Example 6.2 in the PowerPoint notes or on pages 244 to 245 of the textbook.
Consolidated FS-Subsequent to date of purchase type
74
Example 7.3: (contd.)
Also, Sage had a net income of $90,000 for the year-ended 12/31/2000
Note: Post owns 95% of the outstanding shares of Sage Corp.
Consolidated FS-Subsequent to date of purchase type
75
Example 7.3: (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
Consolidated FS-Subsequent to date of purchase type
76
Example 7.3: (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
Consolidated FS-Subsequent to date of purchase type
77
Example 7.3: (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.
Consolidated FS-Subsequent to date of purchase type
78
Example 7.3: (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.)
Consolidated FS-Subsequent to date of purchase type
79
Example 7.3: (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-upa and the amortization of goodwill.b The assets step-up for Sage on 12/31/99 is as follows:
a.$246,000; see p64 of Chapter 6 notes. b.$38,000; see p68 of Chapter 6 notes.
Consolidated FS-Subsequent to date of purchase type
80
Example 7.3: (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
Consolidated FS-Subsequent to date of purchase type
81
Example 7.3: (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
Consolidated FS-Subsequent to date of purchase type
82
Example 7.3: (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)
Intercompany Investment Income 42,750
Investment in Sage Company Common Stock 42,750
Consolidated FS-Subsequent to date of purchase type
83
Example 7.3: (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.)
Consolidated FS-Subsequent to date of purchase type
84
Example 7.3: (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.
Consolidated FS-Subsequent to date of purchase type
85
Example 7.3: (contd.) Note: goodwill in a business
combination involving partially owned subsidiary is attributed to the parent company rather than to 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.
Consolidated FS-Subsequent to date of purchase type
86
Example 7.3: (contd.)
After posting the foregoing entries, Post Corporation’s Investment in Sage Company Common Stock and Intercompany Investment Income ledger accounts are as follows:
Consolidated FS-Subsequent to date of purchase type
87
Example 7.3: (contd.)Investment in Sage Company Common Stock
Date Explanation Debit Credit Balance199912/31 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 950 1,196,050 dr
Consolidated FS-Subsequent to date of purchase type
88
Example 7.3: 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
Consolidated FS-Subsequent to date of purchase type
89
Example 7.3: (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.
Consolidated FS-Subsequent to date of purchase type
90
Developing the eliminations 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:
Consolidated FS-Subsequent to date of purchase type
91
Developing the eliminations 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)
Consolidated FS-Subsequent to date of purchase type
92
Developing the eliminations 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
Consolidated FS-Subsequent to date of purchase type
93
Developing the eliminations 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:
Consolidated FS-Subsequent to date of purchase type
94
Developing the eliminations for Example 7.3 (contd.)
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
Consolidated FS-Subsequent to date of purchase type
95
Developing the eliminations 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
Consolidated FS-Subsequent to date of purchase type
96
Developing the eliminations 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:
Consolidated FS-Subsequent to date of purchase type
97
Developing the eliminations for Example 7.3 (contd.)
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
Consolidated FS-Subsequent to date of purchase type
98
Developing the eliminations 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:
Consolidated FS-Subsequent to date of purchase type
99
Developing the eliminations for Example 7.3 (contd.)
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)
Consolidated FS-Subsequent to date of purchase type
100
Developing the eliminations for Example 7.3 (contd.) Contd.
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)
Consolidated FS-Subsequent to date of purchase type
101
Developing the eliminations for Example 7.3 (contd.) The above eliminations are to carry out the
following:
(1) Eliminate intercompany investment and equity accounts of subsidiary at the beginning of year,and subsidiary
dividends.
(2) Provide for Year 2000 depreciation and amortization on differences between current fair values and carrying
amounts of Sage's identifiable net assets as follows:
Consolidated FS-Subsequent to date of purchase type
102
Developing the eliminations for Example 7.3 (contd.)
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
Consolidated FS-Subsequent to date of purchase type
103
Developing the eliminations for Example 7.3 (contd.)
(3) Allocate unamortized differences between combination date current fair values and carrying amounts to appropriate assets.
(4) 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.)
Consolidated FS-Subsequent to date of purchase type
104
Developing the eliminations for Example 7.3 (contd.)
(b)Minority Interest in Net Income of Subsidiary 2,250
Minority Interest in Net Assets of Subsidiary
2,250
Consolidated FS-Subsequent to date of purchase type
105
Developing the eliminations 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
Consolidated FS-Subsequent to date of purchase type
106
Notes to the elimination entries for Example 7.3 (contd.)1. The working paper eliminations at the time of business combination is as
follows (i.e., 12/31/1999 or 1/1/2000):
Common Stock 400,000
Add. Paid-in Cap. 235,000
Retained Earnings 334,000
Plant Assets 190,000
Leashold 30,000
Inventory 26,000
Goodwill 38,000b
Investment in Sage 1,192,250
Minority Interest 60,750a
Consolidated FS-Subsequent to date of purchase type
107
Notes (contd.)
2. The working paper eliminations for Post Corporation and subsidiary on 12/31/2000 are doing the follows:
a. Eliminate stockholders’ equity of subsidiary as of 1/1/2000.
b. Increase the assets (i.e., plant assets and Leashold) of the subsidiary to the fair value on the business combination date adjusted for depreciation,
Consolidated FS-Subsequent to date of purchase type
108
Notes (contd.)
c. The recognition of additional depreciation expense due to asset step up and the recognition of additional cost of goods sold due to inventory step-up (assuming FIFO).
d. The recognition of goodwill adjusted for the goodwill amortization,
Consolidated FS-Subsequent to date of purchase type
109
Notes (contd.)
e. Elimination of intercompany investment income – post (due to income of Post and Sage will be consolidated in the consolidated income statement).
(all the above accounts are debited in the elimination entries)
(the following accounts are credited in the elimination entries)
Consolidated FS-Subsequent to date of purchase type
110
Notes (contd.)
f. Elimination of investment in sage account balance (due to the assets and liabilities of both companies are to be combined in the consolidated balance sheet statement).
g. Recognize minority interest as a liability ($60,750- $2,000 div. for subsidiary).
h. Elimination of dividends declared by Sage ($40,000= 38,000+2000).
Consolidated FS-Subsequent to date of purchase type
111
Notes :(contd.)
The balance of investment account is $1,196,050. The components of this balance include:
1,192,250 (beg. Balance)
+ 42,750 a
– 950 b
– 38,000 c
1,196,050
a.Post’s share of net increase in Sage’s income of 2000 after adjusting for depreciation exp., etc. (i.e., 85,500 - 42,750). b.amor. of goodwill c.Post’s share of dividends.
Consolidated FS-Subsequent to date of purchase type
112
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
Consolidated FS-Subsequent to date of purchase type
113
Working Paper for Example 7.3: Consolidated Financial Statements for year Ended 12/31/2000 (contd.) Contd.
Statement of Retained Earnings
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
Consolidated FS-Subsequent to date of purchase type
114
Working Paper for Example 7.3: Consolidated Financial Statements for year Ended 12/31/2000 (contd.) Contd.Balance Sheet/
AssetsPost Corp.
Sage Company
Eliminations Inc. (Dec.)
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
Consolidated FS-Subsequent to date of purchase type
115
Working Paper for Example 7.3: Consolidated Financial Statements for year Ended 12/31/2000 (contd.) Contd.
Liabilities &Stockholders’ Equity
Post Corp.
Sage Company
Eliminations Inc. (Dec.)
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
Consolidated FS-Subsequent to date of purchase type
116
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):
Consolidated FS-Subsequent to date of purchase type
117
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
Consolidated FS-Subsequent to date of purchase type
118
Consolidated Financial Statements for Example 7.3 (contd.)
POST CORPORATION AND SUBSIDIARYConsolidated Statement of Retained Earnings
For Year Ended December 31,2000
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
Consolidated FS-Subsequent to date of purchase type
119
Consolidated Financial Statements for Example 7.3 (contd.)
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
Consolidated FS-Subsequent to date of purchase type
120
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
Consolidated FS-Subsequent to date of purchase type
121
Closing Entries for Example 7.3
Post Corporation Closing Entries on 12/31/2000
Net Sales 5,611,000
Intercompany Investment Income 42,750
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.
Consolidated FS-Subsequent to date of purchase type
122
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.
Consolidated FS-Subsequent to date of purchase type
123
Closing Entries for Example 7.3 (contd.)
After posting the above closing entries, Post’s Retained Earnings and Retained Earnings of Subsidiary ledger accounts are as follows:
Consolidated FS-Subsequent to date of purchase type
124
Closing Entries for Example 7.3 (contd.)
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
Consolidated FS-Subsequent to date of purchase type
125
Closing Entries for Example 7.3 (contd.)
Date Explanation Debit Credit Balance200012/31 Close net income not
available for dividends 4,750 4,750 cr
Retained Earnings of Subsidiary
Consolidated FS-Subsequent to date of purchase type
126
Closing Entries for Example 7.3
The retained earnings of subsidiary account balance can be reconciled to the increase in Post’s investment ledger account as follows:
Consolidated FS-Subsequent to date of purchase type
127
Closing Entries for Example 7.3
Reconciliation of Undistributed Earnings of Subsidiary
Undistributed earnings of subsidiary,
year ended Dec. 31, 2000 $4,750
Less: Amortization of goodwill acquired
by parent company in business
combination 950
Increase in balance of Investment in
Sage Company Common Stock ledger
account during 2000 $3,800
Consolidated FS-Subsequent to date of purchase type
128
Closing Entries for Example 7.3
In addition, the total ending balances of Post is equal to consolidated retained earnings as showed below:
Consolidated FS-Subsequent to date of purchase type
129
Closing Entries for Example 7.3
Total of Parent Company’s Two Retained Earnings Account Balances Equals Consolidated Retained Earnings
Balances, Dec. 31, 2000:
Retained earning $1,348,500
Retained earning of subsidiary 4,750
Total $1,353,250
Consolidated FS-Subsequent to date of purchase type
130
Example 7.4 – Equity Method for Partially Owned Purchased Subsidiary for Second Year after Business Combination Continued with the Post Corporation-
Sage Company example, assuming that on 11/22/2001 (the second year after business combination), Sage company declared a dividend of $50,000, payable 12/17/2001, to stockholders of record 12/1/2001.
Consolidated FS-Subsequent to date of purchase type
131
Example 7.4 – Equity Method for Partially Owned Purchased Subsidiary for Second Year after Business Combination (contd.) Sage had a net income of $105,000 for
the year ended 12/31/2001. Based on 95% of ownership, Post’s
share in net income and dividend were $99,750 and $47,500, respectively.
Selected ledger accounts for Post Corp. are as follows after posting subsidiary related income and dividends:
Consolidated FS-Subsequent to date of purchase type
132
Example 7.4 – Equity Method for Partially Owned Purchased Subsidiary for Second Year after Business Combination (contd.)
Investment in Sage Company Stock
1,192,250 dr52,250
Direct out-of-pocketcosts of businesscombination
311,140,000 dr1,140,000
Issuance of commonstock in business combination
12/311999
BalanceCreditDebitExplanationDate
Consolidated FS-Subsequent to date of purchase type
133
Example 7.4 – Equity Method for Partially Owned Purchased Subsidiary for Second Year after Business Combination (contd.) Contd.
1,197,000 dr42,750
Amortization ofdifferences betweencurrent fair values andcarrying amounts ofSage’s identifiable netassets
311,239,750 dr85,500Net income of Sage12/31
1,196,050 dr950Amortization ofgoodwill
31
1,154,250 dr38,000Dividend declared by Sage
11/242000
BalanceCreditDebitExplanationDate
Consolidated FS-Subsequent to date of purchase type
134
Example 7.4 – Equity Method for Partially Owned Purchased Subsidiary for Second Year after Business Combination (contd.) Contd.
1,230,250 dr18,050*
Amortization ofdifferences betweencurrent fair values andcarrying amounts ofSage’s identifiable netassets
311,248,300 dr99,750Net income of Sage12/31
1,229,300 dr950Amortization ofgoodwill
31
1,148,550 dr47,500Dividend declared by Sage
11/222001
BalanceCreditDebitExplanationDate
Consolidated FS-Subsequent to date of purchase type
135
Example 7.4 – Equity Method for Partially Owned Purchased Subsidiary for Second Year after Business Combination (contd.)
Intercompany Investment Income
42,750 cr42,750
Amortization ofdifferences betweencurrent fair values andcarrying amounts ofSage’s identifiable netassets
31
- 0 -42,750Closing entry 31
85,500 cr85,500Net income of Sage12/312000
BalanceCreditDebitExplanationDate
Consolidated FS-Subsequent to date of purchase type
136
Example 7.4 – Equity Method for Partially Owned Purchased Subsidiary for Second Year after Business Combination (contd.) Contd.
81,700 cr18,050*
Amortization ofdifferences betweencurrent fair values andcarrying amounts ofSage’s identifiable netassets
3199,750 cr99,750Net income of Sage12/31
2001BalanceCreditDebitExplanationDate
$ 18,050 Post Corporation’s share 9$19,000 x 0.95)$ 19,000 Total amortization applicable to 2001
5,000 Leasehold amortization ($30,000/6)10,000 Machinery depreciation ($50,000/5)
$ 4,000* Building depreciation($80,000/20)
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137
Developing the Elimination
The working paper eliminations for 12/31/2001, are developed in the similar way as for the eliminations for 12/31/2000. The are as follows:
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138
Developing the Elimination (contd.)Post corporation and Subsidiary
Working Paper EliminationsDecember 31,2001
4,750 Retained Earnings of Subsidiary-Post
2,000 Operating Expenses-Sage17,000 Cost of Goods Sold-Sage36,100 Goodwill (net)-Post($37,050-$950)
20,000 Leasehold(net)-Sage ($25,000-$5,000)
162,000 Plant Assets(net)-Sage($176,000-$14,000)81,700 Intercompany Investment Income-Post
379,250 Retained Earnings-Sage($384,000-$4,750)
235,000 Additional Paid-in Capital–Sage400,000(a)Common Stock–Sage
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139
Developing the Elimination (contd.)
Contd.
58,500Minority Interest in Net Assets of Subsidiary ($61,000 - $2,500)
50,000Dividends Declared-Sage1,229,300
Investment in Sage Company Common Stock-Post
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140
Developing the Elimination (contd.)
The elimination is to carry out the following:
(a) Eliminate intercompany investment, equity accounts of subsidiary at the
beginning of year, and subsidiarydividend.
(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:
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141
Developing the Elimination (contd.)
$ 2,000$ 17,000Totals
5,000Leasehold amortization
10,000Machinery depreciation
$ 2,000$ 2,000Building depreciation
Operating Expenses
Cost of Goods Sold
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142
Developing the Elimination (contd.)
(c) Allocate unamortized differences of the asset step-up.
(d) Establish minority interest in net assets of subsidiary at beginning of year ($61,000), less minority interest share of dividends declared by subsidiary during year ($50,000 x 0.05=$2,500).
(Income tax effects are disregarded.)
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143
Developing the Elimination (contd.)
$105,000 Net income of subsidiary
(19,000) Net reduction in elimination (a) ($17,000+ $2,000)
$ 86,000 Adjusted net income of subsidiary
To establish minority interest in subsidiary’s adjusted net income for Year 2001 as follows:
4,300 Minority Interest in Net Assets
of Subsidiary
$ 4,300 Minority interest share ($86,000 x 0.05)
4,300(b)Minority Interest in Net Income of Subsidiary
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144
Working Paper for Consolidated Financial Statements The eliminations for Post Corp. and
subsidiary described above are illustrated in the following partial working paper for consolidated financial statements. The amounts presented for Post Corp. are assumed.
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145
Working Paper for Consolidated Financial Statements (contd.)
POST CORPORATION AND SUBSIDIARYPartial Working Paper for Consolidated Financial Statements
For Year Ended Dec. 31,2001
1,547,300(434,250)439,0001,542,550Retained earnings, end of year
158,550(a)(50,000) †50,000158,550Dividends declared1,705,850(484,250)489,0001,701,100 Subtotal
352,600 (105,000)*105,000352,600Net income1,353,250(a) (379,250)384,0001,348,500
Retained earnings, beginning of year
ConsolidatedEliminations Inc. (Dec.)
Sage Company
Post Corp.
Statement of Retained Earnings
* Decrease in intercompany investment income ($81,700), plus total increase in costs and expenses ($17,000 + $2,000 + $4,300), equals $ 105,000.
† A decrease in dividends and an increase in retained earnings.
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146
Working Paper for Consolidated Financial Statements (contd.) Contd.
(a) (4,750)4,750Retained earnings of subsidiary
1,547,300(434,250)439,0001,542,550Retained earnings
62,800(a) 58,5000(b) 4,300
Minority interest in net assets of subsidiary
1,560,250(a) (235,000)235,0001,560,250Additional paid-in capital
4,164,550(1,074,000)1,074,0004,164,550 Total stockholders’ equity
xxxx,xxx(1,011,200)x,xxx,xxxx,xxx,xxx Total liabilities & stockholders’ equity
(a) (400,000)400,000Common stock, $10 par1,057,0001,057,000Common stock,$1 par
xxx,xxx62,800xxx,xxxx,xxx,xxx Total liabilities
ConsolidatedEliminations Inc. (Dec.)
Sage Company
Post Corp.
Balance Sheet
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147
Working Paper for Consolidated Financial Statements (contd.) The 12/31/2001 balance of the minority
interest in net assets of subsidiary may be verified as follows:
$ 62,800Minority interest in net assets of subsidiary ($1,256,000 x 0.05)
$1,256,000Sage’s adjusted stockholders’ equity, Dec. 31,2001
182,000
Add: Unamortized difference between combination date current fair values and carrying amounts of Sage’s identifiable net assets ($162,000+ $20,000)
$1,074,000Sage Company’s total stockholders’ equity, Dec. 31, 2001
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148
Closing Entries Post Corp.’s share of the undistributed
earnings of Sage Company for 2001 is $34,200, computed as follows:
$ 34,200
Post’s share of amount of Sage’s adjusted net income not distributed as dividends
47,500Less : Post’s share of dividends declared by Sage ($50,000 x 0.95)
$ 81,700
Adjusted net income of Sage Company recorded by Post Corporation in Intercompany Investment Income ledger account (p.632)
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149
Closing Entries (contd.)
The following are the partial closing entries of Post on 12/31/2001:
318,400Retained earnings (352,600-34,200)
34,200
Retained Earnings of Subsidiary (81,700-47,500)
461,800Income Summary
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150
Closing Entries (contd.)
Following the posting of the closing entries, the two ledger accounts of retained earnings of Post are as follows:
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151
Closing Entries (contd.)Retained Earnings
1,666,900 cr318,400Close net income available for dividends
12/312001
2000
1,348,500 cr158,550Close Dividends Declared account
311,507,050 cr457,050
Close net income available for dividends
12/31
1,508,350 cr158,550Close Dividends Declared account
31
1,050,000 crBalance12/311999
BalanceCreditDebitExplanationDate
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152
Closing Entries (contd.)
Retained Earnings of Subsidiary
38,950 cr34,200Close net income notavailable for dividends
12/312001
2000
4,750 cr4,750Close net income notavailable for dividends
12/31
BalanceCreditDebitExplanationDate
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153
Closing Entries (contd.)
The total balances of these two retained earnings is equal to consolidated retained earnings ( $1,508,350+38,950= $1,547,300).
Also, the $38,950 balance of retained earnings of subsidiary represents Post’s share of the undistributed earnings of Sage since 12/31/99.
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154
Closing Entries (contd.) The undistributed earnings of Sage may be
reconciled to the increase in Post’s Investment ledger account balance as follows:
$ 37,050
Increase in balance of Investment in Sage Company Common Stock ledger account since Dec. 31, 1999, date of business combination ($1,229,300 - $1,192,250)
1,900
Less : Amortization of goodwill acquired in business combination ($950 x 2)
$ 38,950Undistributed earnings of subsidiary
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155
Comments on Equity Method of Accounting The equity method of accounting for a
subsidiary’s operation is preferable to the cost method for the following reasons:
1. The equity method emphasizes economic substance of the parent
– subsidiary relationship. The cost method emphasizes the legal form
of the relationship.
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156
Comments on Equity Method of Accounting (contd.)
2. The equity method allows the use of parent company journal entries to reflect many items that must be included only in working paper elimination in the cost method.
3. The equity method facilitates issuance of separate financial statements for the parent company.
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157
Comments on Equity Method of Accounting (contd.)
4. Except when intercompany profits (gains) or losses exist
in assets or liabilities to be consolidated, the parent
company’s net income and combined retained earnings account balances are identical in the equity method for the related consolidated amounts.
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158
Comments on Equity Method of Accounting (contd.)
5. the cost method is not considered appropriate for accounting for
a pooled subsidiary’s operations. Thus, this textbook emphasizes the
equity method of accounting for a subsidiary’s operations. Note: Regardless whether the cost
method or the equity method is used, consolidated financial statement amounts are the same.
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