ch04 advanced accounting

Financial Accounting and Accounting StandardsAdvanced Accounting, Fifth Edition
Slide 4-*
Describe the accounting treatment required under current GAAP for varying levels of influence or control by investors.
Prepare journal entries on the parent’s books to account for an investment using the cost method, the partial equity method, and the complete equity method.
Understand the use of the workpaper in preparing consolidated financial statements.
Prepare a schedule for the computation and allocation of the difference between implied and book values.
Prepare the workpaper eliminating entries for the year of acquisition (and subsequent years) for the cost and equity methods.
Describe two alternative methods to account for interim acquisitions of subsidiary stock at the end of the first year.
Explain how the consolidated statement of cash flows differs from a single firm’s statement of cash flows.
Understand how the reporting of an acquisition on the consolidated statement of cash flows differs when stock is issued rather than cash.
Describe some of the differences between U.S. GAAP and IFRS in accounting for equity investments.
Learning Objectives
Slide 4-*
Investments in voting stock may be consolidated, or separately reported at
cost,
Effective control
Investment valued using the “cost” method but with adjustments to fair value.
Investment valued using Equity Method
Investment valued using Cost Method or Equity Method (investment eliminated in Consolidation)
Ownership Percentages
LO 1 Varying levels of ownership are accounted for differently.
Fair Value – next slide
Consolidated financial statements will be identical, regardless of method used.
However, if the parent issues parent-only financial statements, the complete equity method should be used for investees over which the parent has either significant influence or effective control.
LO 1 Varying levels of ownership are accounted for differently.
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E4-1: Percy Company purchased 80% of the outstanding voting shares of Song Company at the beginning of 2009 for $387,000. At the time of purchase, Song Company’s total stockholders’ equity amounted to $475,000. Income and dividend distributions for Song Company from 2009 through 2010 are as follows:
Required: Prepare journal entries for Percy Company from the date of purchase through 2011 to account for its investment in Song Company under each of the following assumptions:
LO 2 Journal entries for Parent using cost method.
Accounting for Investments by the Cost Method
Sheet1
2009
2010
2011
Investment in Song 387,000
Dividend income (.8 x $25,000) 20,000
E4-1: A. Percy Company uses the cost method to record its investment.
Sheet1
2009
2010
2011
Cash 40,000
2010
2011
(Liquidating dividend)
E4-1: A. Percy Company uses the cost method to record its investment.
Sheet1
2009
2010
2011
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E4-1: B. Percy Company uses the partial equity method to record its investment.
Accounting for Investments by Partial Equity
LO 2 Journal entries for Parent using partial equity method.
Cash 20,000
Sheet1
2009
2010
2011
Cash 40,000
Sheet1
2009
2010
2011
Sheet1
2009
2010
2011
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E4-1: C. Percy Company uses the complete equity method to record its investment. The difference between book value of equity acquired and the value implied by the purchase price was attributed solely to an excess of market over book values of depreciable assets, with a remaining life of 10 years.
LO 2 Journal entries for Parent using complete equity method.
The complete equity method is usually required to report common stock investments in the 20% to 50% range, assuming the investor has the ability to exercise significant influence and does not have effective control over the investee.
Accounting for Investments by Complete Equity
Sheet1
2009
2010
2011
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E4-1: C. Percy Company uses the complete equity method to record its investment.
Cash 20,000
Sheet1
2009
2010
2011
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Equity income ($7,000 / 10 yrs.) 700
Investment in Song 700
2009
A journal entry is required to adjust for depreciation related to the excess of market over book values of depreciable assets.
Cost of investment $387,000
Slide 4-*
2010
Cash 40,000
Equity income ($7,000 / 10 yrs.) 700
2011
Equity income ($7,000 / 10) 700
Sheet1
2009
2010
2011
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On the date of acquisition, the only relevant financial statement is the consolidated balance sheet.
After acquisition, a complete set of consolidated financial statements must be prepared for the affiliated group:
Income statement,
Consolidated Statements After Acquisition
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P4-8: On January 1, 2010, Parker Company purchased 95% of the outstanding common stock of Sid Company for $160,000. At that time, Sid’s stockholders’ equity consisted of common stock, $120,000; other contributed capital, $10,000; and retained earnings, $23,000.
Required:
A. Prepare a consolidated statements workpaper on Dec. 31, 2010.
B. Prepare a consolidated statements workpaper on Dec. 31, 2011.
LO 3 Use of workpapers.
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LO 4 Preparing Computation and Allocation (CAD) Schedule.
P4-8: Begin the consolidating process by preparing a Computation and Allocation Schedule, as follows:
Difference between implied and book values is established only at the date of acquisition.
Case 1a (2)
$ 160,000
$ 8,421
$ 168,421
Common stock
14,650
771
15,421
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On December 31, 2010, the two companies’ trial balances were as follows at right:
Required A. Prepare a consolidated statements workpaper on December 31, 2010.
LO 5 Workpapers eliminating entries.
Case 1a (2)
Case 1a (2)
Case 1a (2)
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Each section of the workpaper represents one of three consolidated financial statements.
Elimination of the investment account.
Noncontrolling interest in equity 8,421
Investment in Sid 160,000
Elimination of intercompany dividends
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Noncontrolling percentage owned 5%
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+ Parker’s income 129,000
+ Parker’s percentage of Sid income (95%) 24,700
Parker’s dividends declared - 20,000
Parker Company’s retained earnings, 12/31 $154,700
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Total eliminations for all three sections are in balance.
To calculate the noncontrolling interest in net assets or equity at year-end, compute the following:
+ NCI share of Sid income ($26,000 x 5%) 1,300
- NCI share of Sid dividends ($20,000 x 5%) -1,000
Noncontrolling Interest in Equity $ 8,721
Slide 4-*
Required B. Prepare a consolidated statements workpaper on December 31, 2011.
LO 5 Workpapers eliminating entries after acquisition (cost method).
Case 1a (2)
P4-8: B. 2011 After Year of Acquisition
Case 1a (2)
P4-8: B. 2011 After Year of Acquisition
Case 1a (2)
Slide 4-*
Before elimination of the investment account, a workpaper entry is made to the investment account and Parker Company’s beginning retained earnings to recognize Parker’s share of the cumulative undistributed income or loss of Sid Company from the date of acquisition to the beginning of the current year as follows:
Investment in Sid Company 5,700
Retained earnings, 1/1 5,700
Entry to establish Reciprocity
Eliminate investment in Sid Company.
Eliminate intercompany dividends.
LO 5 Workpapers eliminating entries after acquisition (cost method).
All (100%) of Sid’s revenues, expenses, assets, and liabilities are included in the consolidated totals. The noncontrolling interest’s share of income and net assets are shown as separate line items.
Slide 4-*
Equity Method
Record the investment at cost and subsequently adjust the amount each period for
the investor’s proportionate share of the earnings (losses) and
dividends received by the investor.
If investor’s share of investee’s losses exceeds the carrying amount of the investment, the investor ordinarily should discontinue applying the equity method.
Recording Investments – Equity Method
Slide 4-*
Example: (Equity Method) On January 1, 2010, Pennington Corporation purchased 30% of the common shares of Edwards Company for $180,000. During the year, Edwards earned net income of $80,000 and paid dividends of $20,000.
Instructions
Prepare the journal entries for Pennington to record the purchase and any additional entries related to this investment in Edwards Company in 2010.
Slide 4-*
Example: Prepare the entries for Pennington to record the purchase and any additional entries related to this investment in Edwards Company in 2010.
Investment in Stock 180,000
Investment in Stock 24,000
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P4-12: On January 1, 2010, Parker Company purchased 90% of the outstanding common stock of Sid Company for $180,000. At that time, Sid’s stockholders’ equity consisted of common stock, $120,000; other contributed capital, $20,000; and retained earnings, $25,000. Assume that any difference between book value of equity and the value implied by the purchase price is attributable to land.
Required:
A. Prepare a consolidated statements workpaper on Dec. 31, 2010.
B. Prepare a consolidated statements workpaper on Dec. 31, 2011.
Investment Carried at Equity—Year of Acquisition
Slide 4-*
P4-12: Begin the consolidating process by preparing a Computation and Allocation Schedule, as follows:
Difference between implied and book values is established only at the date of acquisition.
Case 1a (2)
$ 180,000
$ 20,000
$ 200,000
Common stock
31,500
3,500
35,000
Slide 4-*
On December 31, 2010, the two companies’ trial balances were as follows:
Required A. Prepare a consolidated statements workpaper on December 31, 2010.
P4-12: A. 2010 Year of Acquisition
Case 1a (2)
P4-12: A. 2010 Year of Acquisition
Case 1a (2)
LO 5 Workpaper eliminating entries (equity method).
Case 1a (2)
The following workpaper entries were made:
To eliminate the account “equity in subsidiary income” and intercompany dividends.
To eliminate the Investment account against subsidiary equity.
To distribute the difference between implied and book value of equity acquired.
Workpaper Observations
Slide 4-*
Required B. Prepare a consolidated statements workpaper on December 31, 2011.
P4-12: B. 2011
Case 1a (2)
Case 1a (2)
Case 1a (2)
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Revenues and expenses of the acquired company are included with those of the acquiring company only from the date of acquisition forward.
Two acceptable alternatives for presenting the subsidiary’s revenue and expense items in the consolidated income statement in the year of acquisition:
Full-year reporting alternative.
Partial-year reporting alternative.
LO 6 Two approaches for interim acquisitions.
Slide 4-*
Equity Method—Full-Year Reporting Alternative
Pillow Company purchased 90% of the common stock of Satin Company on May 1, 2009, for a cash payment of $474,000. December 31, 2009, trial balances for Pillow and Satin were:
P4-16:
Slide 4-*
Satin Company declared a $60,000 cash dividend on December 20, 2009, payable on January 10, 2010, to stockholders of record on December 31, 2009. Pillow Company recognized the dividend on its declaration date. Any difference between book value and the value implied by the purchase price relates to subsidiary land, included in property and equipment.
Required: Prepare a consolidated statements workpaper at December 31, 2009, assuming that Satin Company uses the full-year reporting alternative.
P4-16:
Slide 4-*
P4-16: Computation and Allocation of Difference between Cost and Book Value Acquired:
Interim Acquisitions of Subsidiary Stock
Case 1a (2)
$ 474,000
$ 52,667
$ 526,667
Common stock
45,000
5,000
50,000
8,520
947
9,467
Case 1a (2)
P4-16: Full-Year Reporting Alternative
Interim Acquisitions of Subsidiary Stock
Case 1a (2)
P4-17: (Data from P4-16) Partial-Year Reporting Alternative
Case 1a (2)
Peculiarities:
If the statement of cash flows starts with consolidated net income, then the noncontrolling interest is already included and need not be added back.
Subsidiary dividends paid to the noncontrolling stockholders must be included with dividends paid by the parent company when calculating cash outflow from financing activities.
Subsidiary stock acquired directly from the subsidiary represents an intercompany cash transfer that does not affect the total cash balance of the consolidated group.
Consolidated Statement of Cash Flows
LO 7 Peculiarities of Consolidated Statement of Cash Flows.
Slide 4-*
The preparation of the consolidated statement of cash flows in the year of acquisition is complicated slightly because the comparative balance sheets at the beginning and end of the current year are dissimilar.
Any cash spent or received in the acquisition itself should be reflected in the Investing activities section.
Assets and liabilities of the subsidiary at the date of acquisition must be added to those of the parent at the beginning of the current year.
Consolidated Statement of Cash Flows
LO 8 Stock issued as Consideration in Statement of Cash Flows.
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LO 9 Differences between U.S. GAAP and IFRS.
Application of the Equity Method
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Two categories:
Trial balance format.
Columns are provided for the trial balances, the elimination entries, and normally, each financial statement to be prepared, except for the statement of cash flows.
Note: The consolidated balances derived in a workpaper are the same regardless of the format selected.
Slide 4-*
Two major topics require attention in addressing the treatment of deferred income tax consequences when the affiliates each file separate income tax returns:
Undistributed subsidiary income (Appendix B of Chapter 4).
Elimination of unrealized intercompany profit (discussed in the appendices to Chapters 6 and 7).
Slide 4-*
When affiliated companies elect to file one consolidated return, the tax expense amount is computed on the consolidated workpapers rather than on the individual books of the parent and subsidiary.
The amount of tax expense attributed to each company is computed from combined income and allocated back to each company’s books.
Slide 4-*
When separate tax returns are filed, the parent company will include dividends received from the subsidiary in its taxable income, while the subsidiary’s reported income is included in consolidated net income.
Thus the difference between the subsidiary’s income and dividends paid represents a temporary difference because eventually this undistributed amount will be realized through future dividends or upon sale of the subsidiary.
Slide 4-*
Assume that the parent uses the cost method to account for the investment and that both the parent and the subsidiary file separate tax returns. This means each company records a tax provision based on the items reported on its individual books.
Tax consequences relating to undistributed income are not recorded on the books of the parent company when the investment in the subsidiary is recorded using the cost method.
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If the undistributed income is not expected to be received as a future dividend but is expected to be realized when the investment is sold, the undistributed income is taxed at the capital gains rate
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If the equity method is used to account for the investment, there is a timing difference between books and tax on the books of the parent. Equity income is reported on the parent’s income statement while dividends are included on the tax return.
Therefore, deferred taxes on the parent’s books must reflect the amount of undistributed income in the subsidiary.
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Copyright © 2012 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.
Copyright
200920102011
Dividend distribution25,000 50,000 35,000
Less: Book value of equity acquired:
Common stock114,000 6,000 120,000
Retained earings21,850 1,150 23,000
Difference between implied and book value14,650 771 15,421
Record new goodwill(14,650) (771) (15,421)
Balance-$ -$ -$
ParkerSid
Operating expenses20,000 14,000
Total debits588,000$ 265,000$
Accounts payable19,000$ 12,000$
Other liabilities10,000 20,000
Common stock180,000 120,000
Other expenses20,000 14,000 34,000
Net income129,000 26,000 136,000
Retained Earnings Statement
Retained earnings, 12/31/10149,000$ 29,000$ 42,000$ 19,000$ 300$ 154,700$
Eliminations
Consolidated
Land29,000 34,000 63,000
Other contributed capital60,000 10,000 10,000 60,000
Retained earnings149,000 29,000 42,000 19,000 300 154,700
Noncontrolling interest 1/18,421 8,421 -
Noncontrolling interest 12/318,721$ 8,721
Eliminations
ParkerSid
Total debits679,000$ 300,500$
Other expenses30,000 18,000 48,000
Net income74,000 50,000 105,000
Net income74,000 50,000 19,000 2,500 102,500
Dividends declared(20,000) (20,000) 19,000 (1,000) (20,000)
Retained earnings, 12/31/11203,000$ 59,000$ 48,000$ 24,700$ 1,500$ 237,200$
Eliminations
Consolidated
Difference (cost & book)15,421 15,421 -
Land29,000 34,000 63,000
Retained earnings203,000 59,000 48,000 24,700 1,500 237,200
Noncontrolling interest 1/18,721 8,721
Eliminations
Common stock108,000 12,000 120,000
Difference between implied and book value31,500 3,500 35,000
Allocated to land(31,500) (3,500) (35,000)
Balance-$ -$ -$
ParkerSid
Total debits678,000$ 300,000$
Total revenue318,000 95,000 395,000
Other expenses35,000 15,000 50,000
Net income133,000 20,000 135,000
Retained earnings, 12/31/10168,000$ 30,000$ 43,000$ 13,500$ 500$ 168,000$
Eliminations
Consolidated
Land48,500 45,000 35,000 128,500
Total assets473,000$ 210,000$ 533,500$
Accounts payable20,000$ 15,000$ 35,000$
Other liabilities15,000 25,000 40,000
Retained earnings168,000 30,000 43,000 13,500 500 168,000
Eliminations
ParkerSid
Total debits752,000$ 320,000$
Total revenue282,500 110,000 370,000
Other expenses35,000 20,000 55,000
Net income87,500 25,000 90,000
Retained earnings, 12/31/11235,500$ 40,000$ 52,500$ 13,500$ 1,000$ 235,500$
Eliminations
Consolidated
Land48,500 45,000 35,000 128,500
Total assets537,000$ 220,000$ 598,500$
Accounts payable16,500$ 16,000$ 32,500$
Other liabilities15,000 24,000 39,000
Retained earnings235,500 40,000 52,500 13,500 1,000 235,500
Eliminations
PillowSatin
Dividends declares- 60,000
Total debits3,979,600$ 1,659,200$
Dividends payable- 60,000
Common stock1,000,000 200,000
Common stock180,000 20,000 200,000
Treasury stock(28,800) (3,200) (32,000)
Total book value465,480 51,720 517,200
Difference between implied and book value8,520 947 9,467
Allocated to land(8,520) (947) (9,467)
Balance-$ -$ -$
Consolidated
Total revenue2,030,000 976,000 2,916,000
Other expenses484,000 242,000 726,000
Net income285,000 150,000 345,000
Net income purchased45,000 (45,000)
Dividends declared- (60,000) 54,000 (6,000) -
Retained earnings, 12/31600,360$ 299,200$ 344,200$ 54,000$ 9,000$ 600,360$
Eliminations
Consolidated
Investment in Satin510,000 474,000 -
Total assets2,234,600$ 741,200$ 2,421,267$
Dividends payable60,000 54,000 6,000
Treasury stock(32,000) 32,000 -
Eliminations
Consolidated
Total revenue2,030,000 650,666 2,590,666
Other expenses484,000 161,333 645,333
Net income285,000 100,000 295,000
Dividends declared- (60,000) 54,000 (6,000) -
Retained earnings, 12/31600,360$ 299,200$ 349,200$ 54,000$ 4,000$ 600,360$
Eliminations
Consolidated
Investment in Satin510,000 474,000 -
Total assets2,234,600$ 741,200$ 2,421,267$
Dividends payable60,000 54,000 6,000
Treasury stock(32,000) 32,000 -
Eliminations

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ch04 advanced accounting