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Slide 4-1. Slide 4-2 Consolidated Financial Statements After Acquisition Advanced Accounting, Fourth Edition 44.

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Presentation on theme: "Slide 4-1. Slide 4-2 Consolidated Financial Statements After Acquisition Advanced Accounting, Fourth Edition 44."— Presentation transcript:

1 Slide 4-1

2 Slide 4-2 Consolidated Financial Statements After Acquisition Advanced Accounting, Fourth Edition 44

3 Slide Describe the accounting treatment required under current GAAP for varying levels of influence or control by investors Prepare journal entries on the parent’s books to account for an investment using the cost method, the partial equity method, and the complete equity method Understand the use of the workpaper in preparing consolidated financial statements Prepare a schedule for the computation and allocation of the difference between implied and book values Prepare the workpaper eliminating entries for the year of acquisition (and subsequent years) for the cost and equity methods Describe two alternative methods to account for interim acquisitions of subsidiary stock at the end of the first year Explain how the consolidated statement of cash flows differs from a single firm’s statement of cash flows Understand how the reporting of an acquisition on the consolidated statement of cash flows differs when stock is issued rather than cash Describe some of the differences between U.S. GAAP and IFRS in accounting for equity investments. Learning Objectives

4 Slide 4-4 Investments in voting stock may be consolidated, or separately reported at cost, fair value, or equity. Investments in Stock

5 Slide % % % No significant influence Significant influence (no control) Effective control Investment valued using the “cost” method but with adjustments to fair value. Investment valued using Equity Method Investment valued using Cost Method or Equity Method (investment eliminated in Consolidation) Ownership Percentages Accounting for Investments by the Cost, Partial Equity, and Complete Equity Methods LO 1 Varying levels of ownership are accounted for differently.

6 Slide 4-6 Accounting for Investments by the Cost, Partial Equity, and Complete Equity Methods Consolidated financial statements will be identical, regardless of method used. However, if the parent issues parent-only financial statements, the complete equity method should be used for investees over which the parent has either significant influence or effective control. LO 1 Varying levels of ownership are accounted for differently.

7 Slide 4-7 E4-1: E4-1: Percy Company purchased 80% of the outstanding voting shares of Song Company at the beginning of 2009 for $387,000. At the time of purchase, Song Company’s total stockholders’ equity amounted to $475,000. Income and dividend distributions for Song Company from 2009 through 2010 are as follows: Required: Required: Prepare journal entries for Percy Company from the date of purchase through 2011 to account for its investment in Song Company under each of the following assumptions: LO 2 Journal entries for Parent using cost method. Accounting for Investments by the Cost Method

8 Slide 4-8 Accounting for Investments by the Cost Method LO 2 Journal entries for Parent using cost method. Investment in Song387,000 Cash387, Cash20,000 Dividend income (.8 x $25,000) 20,000 E4-1: E4-1: A. Percy Company uses the cost method to record its investment.

9 Slide 4-9 Accounting for Investments by the Cost Method LO 2 Journal entries for Parent using cost method. Cash40,000 Dividend income (.8 x $50,000) 40, Cash28,000 Investment in Song (.8 x $35,000) 28, (Liquidating dividend ) E4-1: E4-1: A. Percy Company uses the cost method to record its investment.

10 Slide 4-10 E4-1: E4-1: B. Percy Company uses the partial equity method to record its investment. Accounting for Investments by Partial Equity LO 2 Journal entries for Parent using partial equity method. Investment in Song387,000 Cash387, Investment in Song 50,800 Equity income (.8 x $63,500) 50,800 Cash20,000 Investment in Song (.8 x $25,000) 20,000

11 Slide Investment in Song 42,000 Equity income (.8 x $52,500) 42,000 Cash40,000 Investment in Song (.8 x $50,000) 40,000 Accounting for Investments by Partial Equity LO 2 Journal entries for Parent using partial equity method. E4-1: E4-1: B. Percy Company uses the partial equity method to record its investment.

12 Slide Equity loss (.8 x $55,000) 44,000 Investment in Song44,000 Cash28,000 Investment in Song (.8 x $35,000) 28,000 Accounting for Investments by Partial Equity LO 2 Journal entries for Parent using partial equity method. E4-1: E4-1: B. Percy Company uses the partial equity method to record its investment.

13 Slide 4-13 E4-1: E4-1: C. Percy Company uses the complete equity method to record its investment. The difference between book value of equity acquired and the value implied by the purchase price was attributed solely to an excess of market over book values of depreciable assets, with a remaining life of 10 years. LO 2 Journal entries for Parent using complete equity method. The complete equity method is usually required to report common stock investments in the 20% to 50% range, assuming the investor has the ability to exercise significant influence and does not have effective control over the investee. Accounting for Investments by Complete Equity

14 Slide 4-14 E4-1: E4-1: C. Percy Company uses the complete equity method to record its investment. Accounting for Investments by Complete Equity LO 2 Journal entries for Parent using complete equity method. Investment in Song387,000 Cash387, Investment in Song 50,800 Equity income (.8 x $63,500) 50,800 Cash20,000 Investment in Song (.8 x $25,000) 20,000

15 Slide 4-15 E4-1: E4-1: C. Percy Company uses the complete equity method to record its investment. Accounting for Investments by Complete Equity LO 2 Journal entries for Parent using complete equity method. Equity income ($7,000 / 10 yrs.) 700 Investment in Song A journal entry is required to adjust for depreciation related to the excess of market over book values of depreciable assets. Cost of investment$387,000 Book value acquired ($475,000 x 80%) 380,000 Difference between Cost and Book value $ 7,000

16 Slide 4-16 E4-1: E4-1: C. Percy Company uses the complete equity method to record its investment. Accounting for Investments by Complete Equity LO 2 Journal entries for Parent using complete equity method. 2010Investment in Song 42,000 Equity income (.8 x $52,500) 42,000 Cash40,000 Investment in Song (.8 x $50,000) 40,000 Equity income ($7,000 / 10 yrs.) 700 Investment in Song 700

17 Slide 4-17 Accounting for Investments by Complete Equity LO 2 Journal entries for Parent using complete equity method. 2011Equity Loss (.8 x $55,000) 44,000 Investment in Song44,000 Cash28,000 Investment in Song (.8 x $35,000) 28,000 Equity income ($7,000 / 10) 700 Investment in Song 700 E4-1: E4-1: C. Percy Company uses the complete equity method to record its investment.

18 Slide 4-18 On the date of acquisition, the only relevant financial statement is the consolidated balance sheet. After acquisition, a complete set of consolidated financial statements must be prepared for the affiliated group:  Income statement,  Retained earnings statement,  Balance sheet, and  Statement of cash flows LO 3 Use of workpapers. Consolidated Statements After Acquisition

19 Slide 4-19 P4-8: On January 1, 2010, Parker Company purchased 95% of the outstanding common stock of Sid Company for $160,000. At that time, Sid’s stockholders’ equity consisted of common stock, $120,000; other contributed capital, $10,000; and retained earnings, $23,000. Required: A. Prepare a consolidated statements workpaper on Dec. 31, B. Prepare a consolidated statements workpaper on Dec. 31, LO 3 Use of workpapers. Consolidated Statements After Acquisition Year of Acquisition—Cost Method

20 Slide 4-20 Consolidated Statements After Acquisition LO 4 Preparing Computation and Allocation (CAD) Schedule. P4-8: Begin the consolidating process by preparing a Computation and Allocation Schedule, as follows: Difference between implied and book values is established only at the date of acquisition.

21 Slide 4-21 On December 31, 2010, the two companies’ trial balances were as follows at right: Required A. Prepare a consolidated statements workpaper on December 31, Consolidated Statements After Acquisition P4-8: A Year of Acquisition LO 5 Workpapers eliminating entries.

22 Slide 4-22 Consolidated Statements After Acquisition P4-8: A Year of Acquisition LO 5 Workpapers eliminating entries.

23 Slide 4-23 Consolidated Statements After Acquisition P4-8: A Year of Acquisition LO 5 Workpapers eliminating entries.

24 Slide Each section of the workpaper represents one of three consolidated financial statements. 2. Elimination of the investment account. LO 5 Workpapers eliminating entries. Consolidated Statements After Acquisition Workpaper Observations Common stock 120,000 Other contributed capital 10,000 Retained earnings, 1/1 23,000 Difference between Implied and Book15,421 Noncontrolling interest in equity8,421 Investment in Sid160,000

25 Slide Allocation of the difference between implied and book value: LO 5 Workpapers eliminating entries. Consolidated Statements After Acquisition Workpaper Observations Goodwill15,421 Difference between Implied and Book 15, Elimination of intercompany dividends Dividend income19,000 Dividends declared – Sid Company 19,000

26 Slide Noncontrolling interest in consolidated net income: LO 5 Workpapers eliminating entries. Consolidated Statements After Acquisition Workpaper Observations Internally generated income of Sid Company$26,000 Noncontrolling percentage owned5% Noncontrolling interest in income$ 1,300

27 Slide Consolidated retained earnings: LO 5 Workpapers eliminating entries. Consolidated Statements After Acquisition Workpaper Observations Parker Company’s retained earnings, 1/1$ 40,000 + Parker’s income129,000 - Dividends from Sid Company- 19,000 + Parker’s percentage of Sid income (95%)24,700 - Parker’s dividends declared- 20,000 Parker Company’s retained earnings, 12/31$154,700

28 Slide Total eliminations for all three sections are in balance. 8. To calculate the noncontrolling interest in net assets or equity at year-end, compute the following: LO 5 Workpapers eliminating entries. Consolidated Statements After Acquisition Workpaper Observations NCI at Acquisition Date$ 8,421 + NCI share of Sid income ($26,000 x 5%) 1,300 - NCI share of Sid dividends ($20,000 x 5%)-1,000 Noncontrolling Interest in Equity$ 8,721

29 Slide 4-29 On December 31, 2011, the two companies’ trial balances were as follows at right: Required B. Prepare a consolidated statements workpaper on December 31, Consolidated Statements After Acquisition P4-8: B After Year of Acquisition – Cost Method LO 5 Workpapers eliminating entries after acquisition (cost method).

30 Slide 4-30 Consolidated Statements After Acquisition LO 5 Workpapers eliminating entries after acquisition (cost method). P4-8: B After Year of Acquisition

31 Slide 4-31 Consolidated Statements After Acquisition LO 5 Workpapers eliminating entries after acquisition (cost method). P4-8: B After Year of Acquisition

32 Slide Before elimination of the investment account, a workpaper entry is made to the investment account and Parker Company’s beginning retained earnings to recognize Parker’s share of the cumulative undistributed income or loss of Sid Company from the date of acquisition to the beginning of the current year as follows: Consolidated Statements After Acquisition Workpaper Observations LO 5 Workpapers eliminating entries after acquisition (cost method). Investment in Sid Company5,700 Retained earnings, 1/1 5,700 ($29,000 – $23,000 ) X.95 = $5,700 Entry to establish Reciprocity

33 Slide 4-33 The following workpaper entries are also made: 2.Eliminate investment in Sid Company. 3.Eliminate intercompany dividends. 4.Allocate difference between cost and book value. Consolidated Statements After Acquisition Workpaper Observations LO 5 Workpapers eliminating entries after acquisition (cost method). 5. All (100%) of Sid’s revenues, expenses, assets, and liabilities are included in the consolidated totals. The noncontrolling interest’s share of income and net assets are shown as separate line items.

34 Slide 4-34 Equity Method Record the investment at cost and subsequently adjust the amount each period for  the investor’s proportionate share of the earnings (losses) and  dividends received by the investor. If investor’s share of investee’s losses exceeds the carrying amount of the investment, the investor ordinarily should discontinue applying the equity method. Recording Investments – Equity Method LO 5 Workpaper eliminating entries (equity method).

35 Slide 4-35 Example: Example: (Equity Method) On January 1, 2010, Pennington Corporation purchased 30% of the common shares of Edwards Company for $180,000. During the year, Edwards earned net income of $80,000 and paid dividends of $20,000. Instructions Prepare the journal entries for Pennington to record the purchase and any additional entries related to this investment in Edwards Company in Recording Investments – Equity Method LO 5 Workpaper eliminating entries (equity method).

36 Slide 4-36 Example: Example: Prepare the entries for Pennington to record the purchase and any additional entries related to this investment in Edwards Company in Investment in Stock 180,000 Cash 180,000 Cash6,000 Investment in Stock ($20,000 x 30%) 6,000 Investment in Stock24,000 Equity in subsidiary income ($80,000 x 30%) 24,000 Recording Investments – Equity Method LO 5 Workpaper eliminating entries (equity method).

37 Slide 4-37 P4-12: On January 1, 2010, Parker Company purchased 90% of the outstanding common stock of Sid Company for $180,000. At that time, Sid’s stockholders’ equity consisted of common stock, $120,000; other contributed capital, $20,000; and retained earnings, $25,000. Assume that any difference between book value of equity and the value implied by the purchase price is attributable to land. Required: A. Prepare a consolidated statements workpaper on Dec. 31, B. Prepare a consolidated statements workpaper on Dec. 31, Investment Carried at Equity—Year of Acquisition Recording Investments – Equity Method LO 5 Workpaper eliminating entries (equity method).

38 Slide 4-38 P4-12: Begin the consolidating process by preparing a Computation and Allocation Schedule, as follows: Difference between implied and book values is established only at the date of acquisition. Recording Investments – Equity Method LO 5 Workpaper eliminating entries (equity method).

39 Slide 4-39 On December 31, 2010, the two companies’ trial balances were as follows: Required A. Prepare a consolidated statements workpaper on December 31, Recording Investments – Equity Method LO 5 Workpaper eliminating entries (equity method). P4-12: A Year of Acquisition

40 Slide 4-40 Recording Investments – Equity Method LO 5 Workpaper eliminating entries (equity method). P4-12: A Year of Acquisition

41 Slide 4-41 Recording Investments – Equity Method P4-12: A Year of Acquisition LO 5 Workpaper eliminating entries (equity method).

42 Slide 4-42 The following workpaper entries were made: To eliminate the account “equity in subsidiary income” and intercompany dividends. To eliminate the Investment account against subsidiary equity. To distribute the difference between implied and book value of equity acquired. Workpaper Observations Recording Investments – Equity Method LO 5 Workpaper eliminating entries (equity method).

43 Slide 4-43 On December 31, 2011, the two companies’ trial balances were as follows at right: Required B. Prepare a consolidated statements workpaper on December 31, P4-12: B Investment Carried at Equity—After Year of Acquisition Recording Investments – Equity Method LO 5 Workpaper eliminating entries (equity method).

44 Slide 4-44 P4-12: B After Year of Acquisition Recording Investments – Equity Method LO 5 Workpaper eliminating entries (equity method).

45 Slide 4-45 Recording Investments – Equity Method LO 5 Workpaper eliminating entries (equity method). P4-12: B After Year of Acquisition

46 Slide 4-46 Revenues and expenses of the acquired company are included with those of the acquiring company only from the date of acquisition forward. Two acceptable alternatives for presenting the subsidiary’s revenue and expense items in the consolidated income statement in the year of acquisition: Full-year reporting alternative. Partial-year reporting alternative. Interim Acquisitions of Subsidiary Stock LO 6 Two approaches for interim acquisitions.

47 Slide 4-47 Interim Acquisitions of Subsidiary Stock LO 6 Two approaches for interim acquisitions. Equity Method—Full-Year Reporting Alternative Pillow Company purchased 90% of the common stock of Satin Company on May 1, 2009, for a cash payment of $474,000. December 31, 2009, trial balances for Pillow and Satin were: P4-16:

48 Slide 4-48 Satin Company declared a $60,000 cash dividend on December 20, 2009, payable on January 10, 2010, to stockholders of record on December 31, Pillow Company recognized the dividend on its declaration date. Any difference between book value and the value implied by the purchase price relates to subsidiary land, included in property and equipment. Required: Prepare a consolidated statements workpaper at December 31, 2009, assuming that Satin Company uses the full- year reporting alternative. P4-16: Interim Acquisitions of Subsidiary Stock LO 6 Two approaches for interim acquisitions.

49 Slide 4-49 P4-16: Computation and Allocation of Difference between Cost and Book Value Acquired: Interim Acquisitions of Subsidiary Stock LO 6 Two approaches for interim acquisitions.

50 Slide 4-50 P4-16: Full-Year Reporting Alternative Interim Acquisitions of Subsidiary Stock LO 6 Two approaches for interim acquisitions.

51 Slide 4-51 Interim Acquisitions of Subsidiary Stock LO 6 Two approaches for interim acquisitions. P4-16: Full-Year Reporting Alternative

52 Slide 4-52 P4-17: (Data from P4-16) Partial-Year Reporting Alternative Interim Acquisitions of Subsidiary Stock LO 6 Two approaches for interim acquisitions.

53 Slide 4-53 Interim Acquisitions of Subsidiary Stock LO 6 Two approaches for interim acquisitions. P4-17: (Data from P4-16) Partial-Year Reporting Alternative

54 Slide 4-54 Peculiarities: 1.If the statement of cash flows starts with consolidated net income, then the noncontrolling interest is already included and need not be added back. 2.Subsidiary dividends paid to the noncontrolling stockholders must be included with dividends paid by the parent company when calculating cash outflow from financing activities. 3.Subsidiary stock acquired directly from the subsidiary represents an intercompany cash transfer that does not affect the total cash balance of the consolidated group. Consolidated Statement of Cash Flows LO 7 Peculiarities of Consolidated Statement of Cash Flows.

55 Slide 4-55 The preparation of the consolidated statement of cash flows in the year of acquisition is complicated slightly because the comparative balance sheets at the beginning and end of the current year are dissimilar. 1.Any cash spent or received in the acquisition itself should be reflected in the Investing activities section. 2.Assets and liabilities of the subsidiary at the date of acquisition must be added to those of the parent at the beginning of the current year. Consolidated Statement of Cash Flows LO 8 Stock issued as Consideration in Statement of Cash Flows.

56 Slide 4-56 Compare U.S. GAAP and IFRS LO 9 Differences between U.S. GAAP and IFRS. Application of the Equity Method Issue U.S. GAAP IFRS

57 Slide 4-57 Compare U.S. GAAP and IFRS Application of the Equity Method Issue U.S. GAAP IFRS LO 9 Differences between U.S. GAAP and IFRS.

58 Slide 4-58 Compare U.S. GAAP and IFRS Application of the Equity Method Issue U.S. GAAP IFRS LO 9 Differences between U.S. GAAP and IFRS.

59 Slide 4-59 Two categories:  Three-division workpaper format used in this text.  Trial balance format. Columns are provided for the trial balances, the elimination entries, and normally, each financial statement to be prepared, except for the statement of cash flows.

60 Slide 4-60 Two major topics require attention in addressing the treatment of deferred income tax consequences when the affiliates each file separate income tax returns: 1.Undistributed subsidiary income (Appendix B of Chapter 4). 2.Elimination of unrealized intercompany profit (discussed in the appendices to Chapters 6 and 7).

61 Slide 4-61 When affiliated companies elect to file one consolidated return, the tax expense amount is computed on the consolidated workpapers rather than on the individual books of the parent and subsidiary. The amount of tax expense attributed to each company is computed from combined income and allocated back to each company’s books.

62 Slide 4-62 When separate tax returns are filed, the parent company will include dividends received from the subsidiary in its taxable income, while the subsidiary’s reported income is included in consolidated net income. Thus the difference between the subsidiary’s income and dividends paid represents a temporary difference because eventually this undistributed amount will be realized through future dividends or upon sale of the subsidiary.

63 Slide 4-63 Assume that the parent uses the cost method to account for the investment and that both the parent and the subsidiary file separate tax returns. This means each company records a tax provision based on the items reported on its individual books. Tax consequences relating to undistributed income are not recorded on the books of the parent company when the investment in the subsidiary is recorded using the cost method.

64 Slide 4-64 If the undistributed income is not expected to be received as a future dividend but is expected to be realized when the investment is sold, the undistributed income is taxed at the capital gains rate

65 Slide 4-65 If the equity method is used to account for the investment, there is a timing difference between books and tax on the books of the parent. Equity income is reported on the parent’s income statement while dividends are included on the tax return. Therefore, deferred taxes on the parent’s books must reflect the amount of undistributed income in the subsidiary.

66 Slide 4-66 Copyright © 2011 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. CopyrightCopyright


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