Advanced Accounting by Debra Jeter and Paul Chaney Chapter 4: Consolidated Financial Statements after Acquisition Slides Authored by Hannah Wong, Ph.D. Rutgers University

Accounting for Investments obj 1

Accounting Methods for Investments Cost Method The investment account is adjusted only when additional shares are purchased or sold Partial Equity Method The investment account is adjusted for the investor’s share of investee income and dividends Complete Equity Method Additional adjustments are made for unrealized intercompany profit and amortization of purchase differential obj 1

Cost Method Investment Related Accounts of Parent Investment in S Dividend Income Share of dividends declared of S Liquidating dividend Acquisition Cost obj 2

Partial Equity Method Investment Related Accounts of Parent Investment in S Equity in subsidiary income Acquisition Cost Share of dividends declared Equity in subsidiary loss Equity in subsidiary income Equity in subsidiary income Equity in subsidiary loss obj 2

Complete Equity Method Investment Related Accounts of Parent Investment in S Equity in subsidiary income Acquisition Cost Share of dividends declared Equity in subsidiary loss Equity in subsidiary income Equity in subsidiary income Equity in subsidiary loss obj 2

Aid in preparing consolidated financials. Work Paper Format Aid in preparing consolidated financials. Segregated into sections for the income statement, regained earnings statement and balance sheet. See illustration 4-2 on page 128 obj 3

Difference Between Cost and Book Value Cost or Equity Method Actual: Less: Equals: Record: Balance: Purchase Price Total Equity Difference Between Cost & Book Value Difference as Goodwill Zero obj 4

Cost Method - Eliminating Entries (EE) Year of Acquisition The Investment Entry Common Stock - S Company 80,000 Other Contributed Capital - S Company 40,000 1/1 Retained Earnings - S Company 32,000 Difference between cost and book value 13,000 Investment in S Company 165,000 Note: eliminate beginning retained earnings of the subsidiary This entry is the same as the investment entry on the acquisition date (true for the first year only) obj 5

Cost Method - Eliminating Entries (EE) Year of Acquisition The Differential Entry Land 13,000 Difference between cost and book value 13,000 To allocate the differential between cost and book value to the appropriate account(s) This entry is the same as the differential entry on the acquisition date obj 5

Cost Method - Eliminating Entries (EE) Year of Acquisition The Dividend Entry Dividend income - P 8,000 Dividends declared - S 8,000 To eliminate the contra-equity account of the subsidiary To avoid double counting of income obj 5

Noncontrolling Interest in Income Reported income of S + - Adjustments Adjusted NI of S x Noncontrolling % Noncontrolling interest in income obj 5

Controlling Interest in Income Reported income of P + - Adjustments (Adjusted NI of S) x (P %) + Controlling interest in income obj 5

Consolidated Retained Earnings Reported R/E of P + Consolidated NI - Dividends declared of P Consolidated R/E obj 5

Cost Method EE’s After Year of Acquisition The Reciprocal Entry Investment in S Company 16,000 1/1 Retained Earnings - P Company 16,000 Adjust the investment account to equal the amount it would have under equity method Adjust P’s reported beginning R/E to equal beginning consolidated R/E Other Entries (similar to the first year EE) obj 5

Equity Method EE’s Year of Acquisition The Income Entry Equity in subsidiary income 24,000 Investment in S Company 24,000 (To eliminate equity in net income included in reported NI of P) The Dividend Entry Investment in S Company 8,000 Dividends declared 8,000 (To eliminate intercompany dividend) These two entries return the investment account to its beginning balance, to be matched against the subsidiary’s beginning R/E in the next EE. obj 5

Equity Method EE’s Year of Acquisition The Investment Entry Common Stock - S Company 80,000 Other Contributed Capital - S Company 40,000 1/1 Retained Earnings - S Company 32,000 Difference between cost and book value 13,000 Investment in S Company 165,000 Note: eliminate beginning R/E of the subsidiary The Differential Entry Land 13,000 Difference between cost and book value 13,000 To allocate the differential between cost and BV to the appropriate account(s) obj 5

More on Eliminating Entries Equity Method EE’s After Year of Acquisition Similar to entries in the year of acquisition Intercompany revenue and expenses Interest revenue 8,000 Interest expense 8,000 obj 5

Included in consolidated NI Interim Acquisitions Accounting under the purchase method Revenues and expenses of the subsidiary are included with those of parent only from the date of acquisition forward Beginning of S fiscal yr. Acquisition date End of S fiscal yr. Not included in consolidated NI Included in consolidated NI Net income of S obj 6

Interim Acquisitions Full Year Reporting Consolidated Income Statement Revenues and expenses of P Post- acquisition revenues and expenses of S Pre- acquisition revenues and expenses of S Post- acquisition revenues and expenses of S plus + minus Pre-acquisition NI amount of S Noncontrolling interest in income minus Consolidated Net Income obj 6

Interim Acquisitions Partial Year Reporting Consolidated Income Statement Revenues and expenses of P Post- acquisition revenues and expenses of S plus + Noncontrolling interest in income minus Consolidated Net Income obj 6

Consolidated Statement of Cash Flows Purpose to reflect all cash outlays and inflows of the consolidated entity except those between parent and subsidiary obj 7

Consolidated Statement of Cash Flows Procedure derived from consolidated income statement beginning and ending consolidated balance sheets similar to unconsolidated firm, except: noncontrolling interests in combined income subsidiary dividends parent acquisition of additional subsidiary shares obj 7

Consolidated Statement of Cash Flows Cash inflow from operating activities indirect method: add back noncontrolling interest in combined income Cash outflow from financing activities includes subsidiary dividends to noncontrolling shareholders Cash outflow from investing activities excludes parent’s acquisition of additional subsidiary shares directly from subsidiary includes parent’s acquisition of additional subsidiary shares in open market obj 7

Consolidated Statement of Cash Flows Effect of method of payment in an acquisition cash acquisition: cash spent or received is included in the investing activity section of the cash flow statement stock acquisition: issuance of stock or debt is reported in the notes to the financial statements obj 8

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