CHAPTER 3 3 Consolidated Statements: Subsequent to Acquisition Fundamentals of Advanced Accounting 1th Edition Fischer, Taylor, and Cheng

Consolidated Statements Subsequent to Acquisition Two basic methods to maintain the parent’s investment account: Equity Method (Simple & Sophisticated) Cost Method Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Equity Method of Accounting for Investments Equity Method: Parent records income when subsidiary reports income Parent used percent of ownership time sub’s net income to record investment income Dividends treated as return of investment – investment account is reduced Sophisticated Equity Method recognizes amortization on the parent’s ledger for the difference from book value to fair value. Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Cost Method of Accounting for Investments Cost Method: Parent records income when subsidiary declares dividends Most commonly used method No adjustments to investment account Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Example – Company P and Subsidiary Company S Parent purchases 90% of Sub’s stock for $145,000. Sub has equity accounts: Common Stock $100,000 Retained Earnings 50,000 20X1 – Sub: Net Income = $30,000, Dividends = $10,000 20X2 – Sub: Net Loss = ($10,000), Dividends = $5,000 Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

D&D Schedule Example – Company P and Subsidiary Company S Price paid: $ 145,000 Interest acquired: Common stock $ 100,000 Retained earnings 50,000 Total equity 150,000 Ownership interest × 90% 135,000 Excess cost 10,000 Annual Life Amort. Patent …………………………… $10,000 10 $1,000 Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Parent Recording of Subsidiary Income (Year 1) Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Parent Recording of Subsidiary Income (Year 2) Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Worksheet Procedures The RE of the Sub and the Investment account must be at the same point in time Eliminate entries during the year to complete alignment When adjusted to the same point in time, the excess upon elimination will agree with the D&D on purchase date Sophisticated Equity results in only the amortized balance of the excess The account adjustments made require amortization for current and prior periods No entries are made on either firm’s books for worksheet eliminations Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

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

Worksheet Elimination Entries – Simple Equity CY1 Sub Income - Par 27,000 Invest. In Sub - Par 27,000 (Eliminates current year income and creates date alignment) CY2 Invest. In Sub - Par 9,000 Dividends Declared - Sub 9,000 (Eliminates intercompany dividends) EL Common Stock - Sub 90,000 Retained Earnings - Sub 45,000 Invest. In Sub - Par 135,000 (Eliminates investment account against 90% of equity) Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Worksheet Elimination Entries – Simple Equity Continued D Patent 10,000 Invest. In Sub - Par 10,000 (Eliminates balance of investment account and distributes to proper accounts) A Patent Amort. Expense 1,000 Patent 1,000 (Amortized excess cost of the patent over its 10 year life) Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Simple Equity: Worksheet 3-1 Year 1 Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Review of Worksheet Procedures Elimination of equity income and intercompany dividends returns investment to Jan. 1 for date alignment Excess is distributed per D&D; amortized for current and prior years IDS (income distribution schedule) is used to allocate income to P & S All excess amortizations go to P; only P’s share is recorded initially Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Features of Consolidated Statements Consolidated net income is total income earned by the entity. Consolidated net income is distributed to: Parent Non-Controlling interest Retained Earnings statement Shows only controlling interest Consolidated Balance Sheet reports NCI as subdivision of equity Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Worksheet Elimination Entries – Cost Method CY2 Dividend Income - Par 9,000 Dividends Declared - Sub 9,000 (Eliminates intercompany dividends) EL Common Stock - Sub 90,000 Retained Earnings - Sub 45,000 Invest. In Sub - Par 135,000 (Eliminates investment account against 90% of equity) D Patent 10,000 Invest. In Sub - Par 10,000 (Eliminates balance of investment account and distributes to proper accounts) A Patent Amort. Expense 1,000 Patent 1,000 (Amortized excess cost of the patent over its 10 year life) Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Cost Method: Worksheet 3-3 Year 1 Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Subsequent years – Cost Method For periods after the first year, date alignment will not exist. Balance of parents investment account ≠ sub’s retained earnings. Calculate simple equity balance for investment account. Record entry to adjust investment account. DR Investment in Sub – Par CR RE 1/1/20X2 - Par Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Effect of Sophisticated Equity Method on Consolidation Parent amortizes excess costs of net assets Investment account includes only unamortized costs Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Worksheet Elimination Entries – Sophisticated Equity Method CY1 Sub Income - Par 26,000 Invest. In Sub - Par 26,000 (Eliminates current year income and creates date alignment) CY2 Invest. In Sub - Par 9,000 Dividends Declared - Sub 9,000 (Eliminates intercompany dividends) EL Common Stock - Sub 90,000 Retained Earnings - Sub 45,000 Invest. In Sub - Par 135,000 (Eliminates investment account against 90% of equity) D Patent 10,000 Invest. In Sub - Par 10,000 (Eliminates balance of investment account and distributes to proper accounts – includes only UNAMORTIZED excess cost) Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Sophisticated Equity Method: Year 1 Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Disclosure Concerns Consolidated net income – The net income of the consolidated entity NCI share of income – This is the NCI share of consolidated net income; it has often (incorrectly) been treated as an expense. Controlling share of net income – This is the controlling share of consolidated net income; it has often (incorrectly) been treated as consolidated net income (the NCI share having been deducted) Total NCI – Best theory is to show as aggregated part of total equity Some have shown it as liability or put it between liabilities and equity Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

During-the-Year Purchases Option 1 - Close Books (WS 3-7) D&D includes Sub RE on purchase date WS includes Sub operations for only later part of year Option 2 - Books Open (WS 3-8) D&D has Beginning of year RE and “Purchased Income” WS includes Sub operations for entire year Purchased income is used to remove income prior to purchase Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Goodwill Impairment Losses If remaining goodwill is estimated to be less book value of goodwill, record a goodwill impairment loss. Impairment loss is reported on consolidated income statement for period in which it occurs. Presented before-tax basis. Two options for impairment losses: Record loss on parent’s books Record loss on consolidated worksheet. Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Goodwill Impairment Losses - Calculation Company P purchased 80% interest in Company S in 20X2 resulting in $165,000 of Goodwill. 20X4 information is as follows: Invest in Sub (Soph. Equity) $800,000 Estimated fair value of S. Co. 900,000 Est. fair value of net assets 850,000 Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Goodwill Impairment Losses - Calculation Step one – determine if Goodwill is impaired: Investment in Sub $800,000 Fair value of investment 720,000* *($900,000 total fair value x 80% ownership) If investment account exceeds fair value, calculate impairment. Impairment calculation: Est. fair value of company $900,000 Est. fair value of net assets 850,000 Est. goodwill 50,000 Parent’s % of goodwill = $50,000 x 80% = $40,000 Original goodwill calculation 165,000 Goodwill Impairment (125,000) Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.

Tax Issues: Tax-Free Exchange Occurs when seller is not taxed; buyer gets book value for future depreciation Adjustment from market to book accompanied by DTL = tax %  market adjustment DTL has same priority as the related asset. DTL is amortized over same period as asset adjustment; increases tax liability in future years Tax loss carryover is asset recorded in purchase; there are limits on its use in year of purchase and later years Copyright 2008 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.