Consolidated Techniques and Procedures Chapter 4

Prepare consolidated working papers Learning Objective 1 Prepare consolidated working papers for the year of acquisition when the parent company uses the full equity method to account for its investment in a subsidiary.

Equity Method – Year of Acquisition 1. Prep pays $87,000 for 80% interest in Snap on January 1, when Snap stockholders’ equity consists of $60,000 capital stock and $30,000 retained earnings. 2. The $15,000 excess of investment cost is allocated to patents.

Equity Method – Year of Acquisition Snap’s net income and dividends are as follows: 2003 Net income $25,000 Dividends $15,000 2004 Net income $30,000 Dividends $15,000

Working Paper Entries Adjusting and eliminating entries on the working papers do not affect the general ledger accounts. a Income from Snap 18,500 Dividends 12,000 Investment in Snap 6,500 To eliminate income and dividend from Snap and return the investment account to its beginning balance

Working Paper Entries b Minority Interest Expense 5,000 Dividends Snap 3,000 Minority Interest 2,000 To enter minority interest share of subsidiary income and dividends

Working Paper Entries c Retained Earnings, Snap 30,000 Capital Stock, Snap 60,000 Patents 15,000 Investment in Snap 87,000 Minority Interest 18,000 To eliminate reciprocal equity and investment balances, establish beginning minority interest, and enter unamortized patents

Working Paper Entries d Expenses 1,500 Patents 1,500 To enter current amortization

Working Papers for Year of Acquisition Adjustments and Eliminations Consolidated Income Statement Prep Snap Dr. Cr. Statements Revenue Income from Snap Expenses Minority interest Net income Retained earnings P Retained earnings S Add net income Deduct dividends Retained earnings Dec 31 250 18.5 (200) 68.5 5 (30) 43.5 65 (40) 25 30 (15) 40 a 18.5 d 1.5 b 5 c 30 a 12 b 3 315 (241.5) (5) 68.5 5 (30) 43.5

Working Papers for Year of Acquisition Adjustments and Eliminations Consolidated Balance Sheet Prep Snap Dr. Cr. Statements Cash Other current assets Investment in Snap Plant and equipment Accum. depreciation Patents Total assets Liabilities Capital stock Retained earnings Total Minority 1/1 interest 12/31 40 90 93.5 300 (50) 473.5 80 350 43.5 10 50 100 (30) 130 30 60 40 c 15 c 60 a 6.5 c 87 d 1.5 c 18 b 2 50 140 400 (80) 13.5 523.5 110 350 43.5 20 523.5

Sequence of Working Paper Entries 1. Adjustments for errors and omissions in the separate parent company and subsidiary statements 2. Adjustments to eliminate intercompany profits and losses 3. Adjustments to eliminate income and dividends from subsidiary and adjust the investment in subsidiary to its beginning-of-the-period balance

Sequence of Working Paper Entries 4. Adjustment to record the minority interest in subsidiary’s earnings and dividends 5. Elimination of reciprocal investment in subsidiary and subsidiary equity balances 6. Allocation and amortization of cost/book value differentials 7. Elimination of other reciprocal balances

Prepare consolidated working subsequent to acquisition. Learning Objective 2 Prepare consolidated working papers for the year subsequent to acquisition.

Equity Method – Year Subsequent to Acquisition Prep maintains its 80% interest in Snap throughout 2004. The only intercompany transaction during 2004 was a $10,000, non- interest-bearing loan to Snap.

Equity Method – Year Subsequent to Acquisition What is Prep’s income from Snap? ($30,000 × 80%) – $1,500* = $22,500 What is Prep’s investment in Snap account at December 31, 2004? *Patent amortization

Equity Method – Year Subsequent to Acquisition Investment cost January 1, 2003 $ 87,000 Income from Snap, 2003 18,500 Dividends from Snap, 2003 – 12,000 Investment in Snap December 31, 2003 $ 93,500 Income from Snap, 2004 22,500 Dividends from Snap, 2004 – 12,000 Investment in Snap December 31, 2004 $104,000

Consolidation – Year Subsequent to Acquisition Income from Snap 22,500 Dividends 12,000 Investment in Snap 10,500 To eliminate income and dividends from Snap and return the investment account to its beginning-of-the-period balance

Consolidation– Year Subsequent to Acquisition Retained Earnings, Snap 40,000 Capital Stock, Snap 60,000 Patents 13,500 Investment in Snap 93,500 Minority Interest 20,000 To eliminate reciprocal equity and investment balances, establish beginning minority interest, and enter unamortized patents

Consolidation– Year Subsequent to Acquisition Expenses 1,500 Patents 1,500 To enter current amortization Notes Payable, Prep 10,000 Note Receivable, Snap 10,000 To eliminate reciprocal receivable and payable balances

Locate errors in preparing consolidation working papers. Learning Objective 3 Locate errors in preparing consolidation working papers.

Locating Errors Most errors made in consolidating the financial statements will show up when the consolidated balance sheet does not balance. Totals are recomputed. Check individual items. Omissions involving minority interest occur frequently.

Allocate excess of purchase price over book value to include Learning Objective 4 Allocate excess of purchase price over book value to include identifiable net assets.

Excess Allocated to Identifiable Assets Both FASB Statements No. 141 and 142 require firms to provide at least summary disclosures regarding the allocation of the purchase price of an acquired subsidiary.

Excess Allocated to Identifiable Assets (FASB No. 141) Disclose in the year of acquisition: – the cost of the acquired enterprise – a condensed balance sheet (assets and liabilities) – amounts of purchased R&D in process – total amounts assigned to major asset categories

Excess Allocated to Identifiable Assets (FASB No. 142) The amount of goodwill is to be shown as a separate balance sheet line item (assuming it is material).

Additional Disclosures Firms must disclose material noncontrolling interests (minority interest) on the balance sheet. Firms must report noncontrolling interests’ share of subsidiary income (minority interest expense).

Excess Allocation Example Pate acquired its 90% equity interest in Solo on December 31, 2003, for $365,000 cash, when Solo’s stockholders’ equity consisted of $200,000 capital stock and $50,000 retained earnings. During 2004, Solo borrows $20,000 from Pate on a non-interest-bearing note.

Excess Allocation Example What is the excess of cost over book value? 90% × $250,000 = $225,000 $365,000 – $225,000 = $140,000

Excess Allocation Example Solo (000) Fair Book Undervaluation Value Value (Overvaluation) Assets Inventories $ 60 $ 50 $ 10 Land 60 30 30 Buildings 180 100 80 Equipment 70 90 (20) Total $370 $270 $100

Excess Allocation Example Undervaluation Interest Excess Amortization (Overvaluation) Acquired Allocation Period Assets Inventories $10 × 90% = $ 9 Sold in 2004 Land 30 × 90% = 27 None Buildings, net 80 × 90% = 72 36 years Equipment, net (20) × 90% = (18) 9 years Goodwill, remainder 50 None Total $140

Consolidation After Acquisition Solo reports $60,000 net income for 2004. Solo declares dividends of $10,000 on June 1 which is paid on July 1. Solo declares dividends of $10,000 on December 1. The December dividend has not been paid at year end.

Consolidation After Acquisition July 1, 2004 Cash 9,000 Investment in Solo 9,000 To record dividends from Solo December 31, 2004 Investment in Solo 45,000 Income from Solo 45,000 To record dividends from Solo How was this determined?

Consolidation After Acquisition Share of Solo’s net income ($60,000 × 90%) $54,000 Amortization of excess allocated to: Inventories ($9,000 × 100%) – 9,000 Buildings ($72,000 ÷ 36) – 2,000 Equipment ($18,000 ÷ 9 years) + 2,000 Income from Solo for 2004 $45,000

Working Paper Entries a Dividends Receivable 9,000 Investment in Solo 9,000 To correct investment balance for unrecorded dividends receivable b Cash 20,000 Note Receivable, Solo 20,000 To enter receipt of intercompany note receivable

Working Paper Entries c Income from Solo 45,000 Dividends 18,000 Investment in Solo 27,000 To eliminate income and dividend from Pate and return the investment account to the beginning of the period balance

Working Paper Entries d Minority Interest Expense 6,000 Dividends, Solo 2,000 Minority Interest 4,000 To enter minority interest share of subsidiary income and dividends

Working Paper Entries e Retained Earnings, Solo 50,000 Capital Stock, Solo 200,000 Unamortized Excess 140,000 Investment in Solo 365,000 Minority Interest, Jan 1 25,000 To eliminate reciprocal investment and equity amounts, establish beginning minority interest, and enter unamortized excess

Working Paper Entries f Cost of Goods Sold 9,000 Land 27,000 Buildings (net) 72,000 Goodwill 50,000 Equipment (net) 18,000 Unamortized Excess 140,000 To allocate unamortized excess to identifiable assets and goodwill

Working Paper Entries g Operating Expenses 2,000 Buildings (net) 2,000 To enter current depreciation on excess allocated to buildings

Working Paper Entries h Equipment (net) 2,000 Operating Expenses 2,000 To adjust current depreciation for excess allocated to reduce equipment i Dividends Payable 9,000 Dividends Receivable 9,000 To eliminate reciprocal receivables and payables

Apply concepts to prepare a consolidated statement Learning Objective 5 Apply concepts to prepare a consolidated statement of cash flows.

Consolidated Statement of Cash Flows balance sheets Consolidated income statements Consolidated statement of cash flows

Consolidated Statement of Cash Flows 1. During 2004, Seed sold land that cost $20,000 to outside entities for $10,000 cash. 2. Polski issued a $300,000, two-year note on January 8 for new equipment. 3. Patents amortization from the Polski-Seed business combination is $10,000 per year. 4. Polski received $10,000 dividends from its investments in equity investees. 5. Changes in plant assets not explained are due to provisions for depreciation.

Polski and Seed Comparative Balance Sheets at December 31 Assets (000) 2004 2003 Cash $ 255 $ 180 Accts. receivable, net 375 270 Inventories 250 205 Equity investments 100 95 Land 80 100 Buildings, net 200 220 Equipment, net 800 600 Patents 90 100 Total assets $2,150 $1,770 Changes $ 75 105 45 5 (20) 200 (10) $380

Polski and Seed Comparative Balance Sheets at December 31 Liabilities (000) 2004 2003 Accounts payable $ 250 $ 270 Dividends payable 20 20 Notes payable 300 – Common stock 500 500 Other paid-in capital 300 300 Retained earnings 670 600 Minority interest – 20% 110 80 Total liabilities and stockholders’ equity $2,150 $1,770 Changes $(20) – 300 70 30 $380

Consolidated Income Statement Year Ended December 31, 2004 Sales $750 Income from equity investees 15 Total revenue 765 Less expenses: Cost of goods sold 300 Depreciation expense 120 Patents amortization 10 Wages and salaries 54 Other operating expenses 47 Interest expense 24 Loss on sale of land 10 (565) Total consolidated income $200

Consolidated Income Statement Year Ended December 31, 2004 Total consolidated income $200 Less: Minority interest (50) Consolidated net income 150 Consolidated retained earnings 1/1/2004 600 Less: Cash dividends paid (80) Consolidated retained earnings 12/31/2004 $670

Consolidated Statement of Cash Flows Year Ended December 31, 2004 Cash flows from operating activities Consolidated net income $150 Adjustments to reconcile net income to cash provided by operating activities Minority interest $ 50 Undistributed income–equity investees (5) Loss on sale of land (10) Depreciation on equipment 100 Depreciation on buildings 20 Amortization of patents 10 Increase in accounts receivable (105) Increase in inventories (45) Decrease in accounts payable (20) 15 Net cash flows from operating activities $165

Consolidated Statement of Cash Flows Year Ended December 31, 2004 Net cash flows from operating activities $165 Cash flows from investing activities 10 Cash flows from financing activities Payment of cash dividends–majority $(80) Payment of cash dividends–minority (20) (100) Increase in cash for 2004 75 Cash on January 1, 2004 180 Cash on December 31, 2004 $255

End of Chapter 4