Advanced Accounting, Third Edition 8 Changes in Ownership Interest Advanced Accounting, Third Edition

Learning Objectives Identify the types of transactions that change the parent company’s ownership interest in a subsidiary, and summarize the differences between current and proposed GAAP. Describe the eliminating entries needed when the parent acquires subsidiary shares through multiple open market purchases. Explain how the parent determines the cost basis of subsidiary shares sold subsequent to acquisition. Compute the controlling interest in income after the parent sells some shares of the subsidiary company. 1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements? Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases). Forward-looking Information Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image). Timeliness (no real time financial information)

Learning Objectives Describe the effect on the eliminating process when the subsidiary issues new shares entirely to the parent, and the parent pays either more or less than the book value of the subsidiary shares. Describe the impact on the parent’s investment account when the subsidiary issues new shares and either the new shares are purchased ratably by the parent and noncontrolling shareholders or entirely by the noncontrolling shareholders. 1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements? Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases). Forward-looking Information Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image). Timeliness (no real time financial information)

Changes in Ownership Interest Parent company can increase its ownership interest in a subsidiary by either buying additional subsidiary shares directly from third parties or having a subsidiary purchase its (subsidiary’s) shares from third parties. Parent company can decrease its ownership interest in a subsidiary by either selling some subsidiary shares directly to third parties or having a subsidiary sell additional shares (including treasury shares) to third parties. LO 1 Changes in ownership and differences between current and proposed GAAP.

Changes in Ownership Interest Current GAAP: Acquisitions of additional shares are handled in a step-by-step manner. Sales of shares are handled the same as any sale of an asset. LO 1 Changes in ownership and differences between current and proposed GAAP.

Changes in Ownership Interest Proposed GAAP: Acquisitions that take place in stages or partial sales: Measure and recognize acquiree’s identifiable assets and liabilities at 100% of their fair values on date the acquirer obtains control, and Recognize all acquiree’s goodwill (not just parent’s share), measured as difference between fair value of acquiree on acquisition date and fair value of identifiable net assets. (Continued) LO 1 Changes in ownership and differences between current and proposed GAAP.

Changes in Ownership Interest Proposed GAAP: Acquisitions that take place in stages or partial sales: Any previously held noncontrolling equity interests should be remeasured to fair value, with resulting adjustment recognized in income. After control is achieved, subsequent adjustments due to increased ownership are shown as Additional Contributed Capital, not as income. If parent loses control, retained investment should be remeasured to fair value with adjustments recognized in net income. LO 1 Changes in ownership and differences between current and proposed GAAP.

Parent Acquires Subsidiary Stock Through Several Open-Market Purchases—Cost Method When more than one purchase is made before control is obtained, acquisition date is date when control is achieved. Current GAAP (Interpretation No. 2 of APB Opinion No. 17): Requires purchasing company to identify the cost of each investment, the fair value of the underlying assets acquired, and the difference between cost and book value for each step purchase. Previously held interests are not revalued at the date of subsequent purchases. LO 2 Eliminating Investment.

Parent Acquires Subsidiary Stock Through Several Open-Market Purchases—Cost Method Proposed GAAP (Exposure Draft, Business Combinations, June 30, 2005): Previously held noncontrolling equity interest should be remeasured to fair value when control is achieved, and the resulting adjustment should be recognized in net income. If a parent loses control but retains a noncontrolling interest, the portion retained should be remeasured to fair value on the date control is surrendered and the adjustment reflected in the income statement. LO 2 Eliminating Investment.

Several Open-Market Purchases—Cost Method P8-1 Sarko Company had 300,000 shares of $10 par value common stock outstanding at all times, and retained earnings balances as indicated here: January 1, 2004 $ 260,000 January 1, 2005 540,000 January 1, 2006 630,000 January 1, 2007 820,000 Pelzer Co. acquired Sarko Co. common stock on the open market: January 1, 2004 30,000 shares (10%) $ 365,000 January 1, 2005 75,000 shares (25%) 960,000 January 1, 2006 135,000 shares (45%) 1,860,000 Total 240,000 shares (80%) $3,185,000 LO 2 Eliminating Investment.

Several Open-Market Purchases—Cost Method Computation and Allocation of Difference Schedule January 1, 2006 January 1, 2006 P Company payment $ 1,860,000 Percentage acquired / 45% Implied value $4,133,333 LO 2 Eliminating Investment.

Several Open-Market Purchases—Cost Method Because Pelzer Company has owned a percentage of Sarko Company since January 1, 2004, a workpaper entry is needed on December 31, 2006, to convert to equity/establish reciprocity from 2004 to the beginning of 2006 as follows: Investment in Sarko Company 59,500 1/1 Retained Earnings—Pelzer Company 59,500 LO 2 Eliminating Investment.

Several Open-Market Purchases—Cost Method The investment is eliminated by the following workpaper entry on December 31, 2006, (per CAD Schedule): January 1, 2006 Common Stock—Sarko Company 3,000,000 1/1 Retained Earnings—Sarko Company 630,000 Difference Between Implied and Book Value 503,333 Investment in S Company * 3,306,666 Noncontrolling Interest in Equity 826,667 LO 2 Eliminating Investment.

Several Open-Market Purchases—Cost Method The following workpaper entry (Dec. 31, 2006), is made to allocate difference between implied and book value to goodwill. January 1, 2006 Goodwill 503,333 Difference Between Implied and Book Value 503,333 LO 2 Eliminating Investment.

Parent Sells Subsidiary Stock Investment on the Open Market Under the Exposure Drafts (ED No. 1204-001 and 1205-001), the treatment of the sale of a portion (but not all) of its investment by a parent company depends on whether or not the sale results in the loss of effective control of the subsidiary. If control is lost, the entire interest would be adjusted to fair value under this proposal, and a gain of loss recorded in income on all shares owned prior to sale. Note, however, this proposed treatment is controversial. LO 3 Determining the cost basis of the shares sold.

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