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

Definition of Subsidiary Parent Company controls Subsidiary

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

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

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

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

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) 260,000 Common stock (20,000x$10) 200,000 Other contributed capital(20,000x$3) 60,000 Other contributed capital 5,000 Cash 5,000 Investment in S Company 10,000 Cash 10,000 Direct costs are part of purchase price and increase the investment account Registration costs reduce the other contributed capital

Intercompany Accounts to be Eliminated

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

Case 1(a) Cost = BV, 100% 0wnership Journal Entry Investment in S Company 80,000 Cash 80,000 Eliminating Entry Common Stock - S Company 50,000 Other Contributed Capital - S Company 10,000 Retained Earnings - S Company 20,000 Investment in S Company 80,000 The shareholders’ equity accounts in the subsidiary’s books represent the parent’s investment in the net assets of the subsidiary The investment account in the parent’s books record the parent’s investment in the net assets of the subsidiary

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

Case 1(b) Cost = BV, Partial 0wnership Journal Entry Investment in S Company 72,000 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

Case 1(b) Cost = BV, Partial 0wnership The Investment Eliminating Entry Common Stock - S Company 45,000 Other Contributed Capital - S Company 9,000 Retained Earnings - S Company 20,000 Investment in S Company 72,000 90% of the subsidiary’s shareholders’ equity accounts, representing the parent’s investment in the net assets of the subsidiary, is eliminated. The investment account in the parent’s books record the parent’s investment in the net assets of the subsidiary

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.

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

Case 2(b) Cost > BV, Partial 0wnership Journal Entry Investment in S Company 74,000 Cash 74,000 Computation and Allocation of Difference 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

Case 2(b) Cost > BV, Partial 0wnership The Investment Eliminating Entry Common Stock - S Company 40,000 Other Contributed Capital - S Company 8,000 Retained Earnings - S Company 16,000 Difference between Cost and Book Value 10,000 Investment in S Company 74,000 The Allocation Eliminating Entry Land 10,000 Difference between Cost and Book Value 10,000 The difference between cost and book value is recorded and allocated to the appropriate account (Land) The investment account is eliminated against 80% of the equity accounts of the subsidiary

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

Case 3(b) Cost < BV, Partial 0wnership Journal Entry Investment in S Company 60,000 Cash 60,000 Computation and Allocation of Difference 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

Case 3(b) Cost < BV, Partial 0wnership The Investment Eliminating Entry Common Stock - S Company 40,000 Other Contributed Capital - S Company 8,000 Retained Earnings - S Company 16,000 Difference between Cost and Book Value 10,000 Investment in S Company 60,000 The Allocation Eliminating Entry Difference between Cost and Book Value 4,000 Land 4,000 The difference between cost and book value is recorded and allocated to the appropriate account (Land) The investment account is eliminated against 80% of the equity accounts of the subsidiary

Why Would an Acquiring Company Pay Less than Book Value Overvaluation of assets Undervaluation of long term liabilities Bargain purchase

Subsidiary Treasury Stock Holdings The Investment Eliminating Entry Common Stock - S Company 187,500 Other Contributed Capital - S Company 37,500 Retained Earnings - S Company 93,750 Difference between Cost and Book Value 16, 250 Investment in S Company 320,000 Treasury Stock 15,000 The remainder of the treasury stock is carried over as a reduction in non-controlling interests in net assets The parent’s share of treasury stock is eliminated

Other Eliminations Cash Advance Receivable/Payable Advance 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

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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