3 - 0 Advanced Accounting by Debra Jeter and Paul Chaney Chapter 3: Consolidated Financial Statements - Date of Acquisition Slides Authored by Hannah Wong,

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Advanced Accounting by Debra Jeter and Paul Chaney

Chapter 3: Consolidated Financial Statements - Date of

Acquisition

Slides Authored by Hannah Wong, Ph.D.Rutgers University

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Definition of Subsidiary

Parent Company

Subsidiary

controls

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What is Control?

the ability to direct the policies and management of another entity

decision making ability that is not shared with others

means of control:ownership of voting shares

(often over 50%)

by contract

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Who Should be Consolidated?

Companies under common control

Generally all majority-owned subsidiaries

Exceptions:

ownership is temporary

control does not rest with the majority owner e.g., legal reorganization or bankruptcy

foreign subsidiary subject to government restrictions

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Consolidated Financial Statements

Intended readers stockholders and creditors of

the parent company

Purpose to present the financial position and

operating results of a parent company and its subsidiaries as if the group were a single company

Reason substance over form i.e. economic entity VS legal entity

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Parent’s JE at Acquisition Date

Case A: P Company acquires all 10,000 shares of the common stock of S Company for $25 per share and pays acquisition fee of $10,000.

Investment in S Company 260,000

Cash 260,000

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Parent’s JE at Acquisition Date

Case B: P Company issues 20,000 of its $10 par value common shares with a fair value of $13 per share for the shares of S Company. P Company paid registration costs of $5,000 and a finder’s fee of $10,000.

Investment in S Company (20,000x$13) 260,000Common stock (20,000x$10) 200,000Other contributed capital(20,000x$3) 60,000

Other contributed capital 5,000Cash 5,000

Investment in S Company 10,000Cash 10,000

Direct costs are part of purchase price and increase the investment account

Registration costs reduce the other contributed capital

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Intercompany Accounts to be Eliminated

Parent’s Accounts VS Subsidiary’s Accounts

Investment in Subsidiary Equity Accounts

Intercompany receivable(payable)

Intercompany payable(receivable)

Advances to (from)subsidiary

Advances from (to) parent

Interest revenue (expense) Interest expense (revenue)

Dividend revenue(dividends declared)

Dividends declared(dividends revenue)

Management fee receivedfrom subsidiary

Management fee paid toparent

Sales to (purchases ofinventory from) subsidiary

Purchases of inventory(sales to) parent

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Computation and Allocation of Difference between Cost and Book Value

Cost of Investment (Purchase Price)

- Book Value of Equity Acquired

(Sum of Equity Accounts of S Company

x percentage acquired)

= Difference between Cost and Book Value

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Case 1(a) Cost = BV, 100% 0wnership

Journal EntryInvestment in S Company 80,000

Cash 80,000

Eliminating EntryCommon Stock - S Company 50,000

Other Contributed Capital - S Company 10,000

Retained Earnings - S Company 20,000


The investment account in theparent’s books record

the parent’s investment in the net assets of the subsidiary

The shareholders’ equity accountsin the subsidiary’s books represent


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Case 1(a) Cost = BV, 100% 0wnership Illustration 3-2

About the consolidated balances: Investment in S Company = 0 Subsidiary’s net assets are substituted for

the investment account. Consolidated assets and liabilities =

parent’s + subsidiary’s Consolidated S/E = parent’s S/E

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Case 1(b) Cost = BV, Partial 0wnership


Cash 72,000

Computation and Allocation of Difference

between Cost and Book Value

Cost of Investment 72,000

- Book Value of Equity Acquired (80,000 x90%)72,000

= Difference between Cost and Book Value 0

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Case 1(b) Cost = BV, Partial 0wnership

The Investment Eliminating Entry

Common Stock - S Company 45,000




The investment account in theparent’s books record


90% of the subsidiary’s shareholders’ equity accounts,

representing the parent’s investment in the net assets

of the subsidiary, is eliminated.

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Case 1(b) Cost = BV, Partial 0wnership Illustration 3-3

About the consolidated balances:

100% of subsidiary’s assets and liabilities are included.

Only 90% of subsidiary’s S/E accounts are eliminated.

The other 10% is non-controlling shareholders’ interest in the net assets.

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Non-controlling Interests

Definition the stock of the subsidiary which is not

controlled by the parent

Presentation

Non-controlling interests in net assets can be presented in the consolidated balance sheet as:

a liability; part of shareholders’ equity; or a separate section

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Case 2(b) Cost > BV, Partial 0wnership


Cash 74,000


between Cost and Book Value Cost of Investment 74,000

- Book Value of Equity Acquired (80,000x80%) 64,000

= Difference between Cost and Book Value 10,000

Adjust land upward (mark toward market) (10,000)

Balance 0

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Case 2(b) Cost > BV, Partial 0wnership

The Investment Eliminating EntryCommon Stock - S Company 40,000



Difference between Cost and Book Value 10,000


The Allocation Eliminating Entry

Land 10,000


The investment account is eliminatedagainst 80% of the equity accounts

of the subsidiary

The difference between cost and book value is recorded

and allocated to the appropriate account (Land)

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Why Would an Acquiring Company Pay More than Book Value

Appreciation of assets expense of costs that contains future benefits accelerated depreciation methods LIFO inventory method unrealized gains that are unrecognized

Goodwill

Overvaluation of long term liabilities

Other market factors, e.g. competitor acquirer

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Case 3(b) Cost < BV, Partial 0wnership


Cash 60,000


between Cost and Book Value Cost of Investment 60,000

- Book Value of Equity Acquired (80,000x80%) 64,000

= Difference between Cost and Book Value (4,000)

Adjust land downward (mark toward market) 4,000

Balance 0

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Case 3(b) Cost < BV, Partial 0wnership





Investment in S Company60,000

The Allocation Eliminating EntryDifference between Cost and Book Value 4,000

Land 4,000

The investment account is eliminatedagainst 80% of the equity accounts

of the subsidiary

The difference between cost and book value is recorded

and allocated to the appropriate account (Land)

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Why Would an Acquiring Company Pay Less than Book Value

Overvaluation of assets

Undervaluation of long term liabilities

Bargain purchase

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Subsidiary Treasury Stock Holdings




Difference between Cost and Book Value 16, 250


Treasury Stock 15,000

The parent’s share of treasury stock is eliminated

The remainder of the treasury stock is carried over as a reduction in

non-controlling interests in net assets

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Other Eliminations

Cash AdvanceAdvance from P Company 25,000

Advance to S Company 25,000

Receivable/Payable Accounts Payable (to S) 100,000

Accounts Receivable (from P) 100,000

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Limitations of Consolidated Statements

Limited information for non-controlling stockholders, subsidiary creditors, and regulatory agencies

Combining financial information of firms in different industries make the statements difficult to analyze

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Advanced Accounting

by

Debra Jeter and Paul Chaney

Copyright © 2001 John Wiley & Sons, Inc. All rights reserved.Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

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3 - 0 Advanced Accounting by Debra Jeter and Paul Chaney Chapter 3: Consolidated Financial Statements - Date of Acquisition Slides Authored by Hannah Wong,