Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Acquisitions and Consolidated Statements © The McGraw-Hill Companies, Inc., Part One: Financial Accounting

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Slide 12-1 If an investor company owns less than 20 percent of an investee company’s common stock, and the stock’s fair value is readily determinable, the investment is reported using the fair value method. Fair-Value Method

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Fair-Value Method Slide 12-2 When a dividend is received, the entire amount is credited to Dividend Revenues. Cash50,000 Dividend Revenues50,000

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Cost Method Slide 12-3 If an investor company owns less than 20 percent of an investee company’s common stock, and the stock’s fair value is not readily determinable, the investment is reported at its cost.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Equity Method Slide 12-4 If the investing company owns less than 50 percent of the voting stock, but can significantly influence the actions of the investee, the investment is accounted for by the equity method.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Equity Method Slide 12-5 Merkle Company acquired 25 percent of the common stock of Pentel Company on January 2, 1998, for $250,000. Investments250,000 Cash250,000 Pentel’s net income for 1998 was $100,000. Investments25,000 Investment Revenue25,000 25% of $100,000 Assume that Merkle Company has significant influence significant influence Assume that Merkle Company has significant influence significant influence

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Equity Method Slide 12-6 During 1998, Merkle Company received $10,000 in dividends from Pentel Company. Cash10,000 Investments10,000 Note that the dividend reduces the Investments account.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Over 50%consolidated statements 20-50%equity method Less than 20%fair-value method Consolidated Basis Slide 12-7 Amount of Ownership Method of Reporting Corporation B

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 The acquiring corporation issues only common stock with rights identical to the majority of its outstanding voting common stock in exchange for substantially all of the voting common stock of the acquired company. Each combining company is autonomous and has not been a subsidiary or division of another corporation within the previous two years. The combination is effected in a single transaction or is completed according to a specific plan within on year. The acquiring corporation issues only common stock with rights identical to the majority of its outstanding voting common stock in exchange for substantially all of the voting common stock of the acquired company. Each combining company is autonomous and has not been a subsidiary or division of another corporation within the previous two years. The combination is effected in a single transaction or is completed according to a specific plan within on year. Pooling Slide 12-8 If all of the following are met, pooling is required: Keep going! There are two more requirements.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Following the combination the acquiring corporation does not reacquire its voting common stock for a six- month period other than for normal business purposes, such as the issuance of shares under stock option programs. The combined corporation does not intend to dispose of a significant part of the assets of the combining companies within two years after the combination. Following the combination the acquiring corporation does not reacquire its voting common stock for a six- month period other than for normal business purposes, such as the issuance of shares under stock option programs. The combined corporation does not intend to dispose of a significant part of the assets of the combining companies within two years after the combination. Pooling Slide 12-9 If all of the following are met, pooling is required:

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Pro-Forma Consolidated Balance Sheet Slide Pooling Purchase Assets Cash and marketable securities$ 7,000$ 7,000 Accounts receivable6,4006,400 Inventories 8,200 8,200 Total current assets21,60021,600 Goodwill--- 1,500 Plant and equipment, net13,40014,500 Total assets$35,000$37,600 Assets Cash and marketable securities$ 7,000$ 7,000 Accounts receivable6,4006,400 Inventories 8,200 8,200 Total current assets21,60021,600 Goodwill--- 1,500 Plant and equipment, net13,40014,500 Total assets$35,000$37,600 Assets Section

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Pro-Forma Consolidated Balance Sheet Slide Pooling Purchase Liabilities and Shareholders’ Equity Accounts payable$ 7,700$ 7,700 Other current liabilities 1,800 1,800 Total current liabilities9,5009,500 Long-term debt 9,800 9,800 Total liabilities19,30019,300 Common stock (par plus paid-in capital)3,2008,500 Retained earnings12,500 9,800 Total shareholders’ equity15,70018,300 Total liabilities and shareholders’ equity$35,000$37,600 Liabilities and Shareholders’ Equity Section

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Accounting as a Pooling Slide There is a “marriage” of the two entities. The two balance sheets simply are added together at book value to arrive at a consolidated balance sheet for the surviving entity.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Accounting as a Purchase Slide First, B’s identifiable net assets are revalued to their fair value. Plant and equipment had a book value of $2.8 million, but a fair value of $3.9 million. The consolidated plant and equipment account shows $14.5 million.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Accounting as a Purchase Slide Second, any excess of the purchase price over the total amount of the revalued identifiable net assets is shown on the consolidated balance sheet as an asset called goodwill. Purchase price$6,000,000 Less: Book value of net assets acquired3,400,000 2,600,000 Less: Write-up of identifiable assets to fair value1,100,000 Goodwill$1,500,000 Purchase price$6,000,000 Less: Book value of net assets acquired3,400,000 2,600,000 Less: Write-up of identifiable assets to fair value1,100,000 Goodwill$1,500,000

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Pro Forma Consolidated Income Statement Slide Corporation A Corporation B If independent corporation: Income before taxes$3,780$945 Income tax expense (40%)1, Net income$2,268$567 Number of outstanding shares1,000,000100,000 Earnings per share$2.27$5.67

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Pro Forma Consolidated Income Statement Slide Combined A-B, pooling treatment: Income before taxes$4,725 Income tax expense (40%)1,890 Net income$2,835 Number of outstanding shares1,200,000 Earnings per share$2.36 Combined Corporations A-B

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Pro Forma Consolidated Income Statement Slide Combined A-B, purchase treatment: Income before taxes$4,725 Less: Additional depreciation expense110 Less: Amortization of goodwill 100 Income before taxes4,515 Income tax expense (40%)1,806 Net income$2,709 Number of outstanding shares1,200,000 Earnings per share$2.26 Combined Corporations A-B

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Assets Cash45,00012,00057,000 Accounts receivable40,00011,000(1) 5,00046,000 Inventory30,00015,000(4) 2,00043,000 Fixed assets, net245,00045,000290,000 Investment in subsidiary55, (2) 55, ,00083,000436,000 Liabilities and SH Equity Accounts payable20,00013,000(1) 5,00028,000 Other current liabilities25,0009,00034,000 Long-term liabilities100, ,000 Capital stock100,00040,000(2) 40,000100,000 Retained earnings170,00021,000(2) 15,000 (4) 2,000174, ,00083,000436,000 Consolidated Worksheet Slide Separate Intercompany Consolidated Statements Eliminations Balance Parent Subsidiary Dr. Cr. Sheet

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Asset Valuation Slide Assume that the Parent purchased Subsidiary stock for $70,000 rather than $55,000. If Subsidiary’s assets were found to be recorded at their fair value, there would be goodwill of $15,000. The elimination entry would have been: Goodwill15,000 Capital Stock (Subsidiary)40,000 Retained Earnings (Subsidiary)15,000 Investment in Subsidiary (Parent)70,000

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., % of subsidiary capital stock$ 8,000 20% of subsidiary retained earnings at time of acquisition3,000 20% of the $6,000 increase in subsidiary retained earnings since acquisition1,200 Less 20% of the $2,000 intercompany profits (400) Total minority interest$11,800 20% of subsidiary capital stock$ 8,000 20% of subsidiary retained earnings at time of acquisition3,000 20% of the $6,000 increase in subsidiary retained earnings since acquisition1,200 Less 20% of the $2,000 intercompany profits (400) Total minority interest$11,800 Minority Interest Slide If Parent had purchased less than 100 percent of Subsidiary’s stock, then there would have been minority interest. The majority example shown in this chapter is $11,800. This is the net of four items:

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Chapter 12 The End