Advanced Accounting Debra Jeter Paul Chaney.

Advanced Accounting Debra Jeter Paul Chaney

Table Of Contents 1: Introduction to Business Combinations 3
2: Methods of Accounting for Business Combinations 3: Consolidated Financial Statements - Date of Acquisition 52 4: Consolidated Financial Statements after Acquisition 76 5: Allocation, Depreciation, and Amortization of the Difference between Cost and Book Value 6: Elimination of Unrealized Profit on Intercompany Sales of Inventory 7: Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment 148 8: Changes in Ownership Interest 9: Indirect Ownership and Reciprocal Stockholdings 208

10:ConsolidatedFinancialStatements - Miscellaneous Topics 236
11: Alternative Concepts of Consolidated Financial Statements 259 12: International Accounting and the Global Economy 283 13: Accounting for Foreign Currency Transactions 306 14: Translation of Financial Statements of Foreign Affiliates 337 15: Reporting for Segments and for Interim Financial Periods 358 16: Partnerships: Formation, Operation, and Ownership Changes 381 17: Partnership Liquidation 18: Introduction to Fund Accounting 19: Introduction to Accounting for State and Local Governmental Units 20: Accounting for Nongovernment Non business Organizations 496

Advanced Accounting by Debra Jeter and Paul Chaney
Chapter 1: Introduction to Business Combinations

Types of Business Combinations
Friendly Combinations Boards of directors of combining companies negotiate terms of proposed combination.

Types of Business Combinations
Unfriendly (Hostile) Combinations Board of directors of target company resists the combination. The acquiring company deals directly with individual shareholders through a tender offer.

Defense Tactics Poison pill: stock rights of shareholders to purchase additional shares at a bargain price in the event of a potential takeover. Greenmail: purchase of shares held by acquiring company at a premium price.

Defense Tactics White knight or white squire: encourage a friendly firm to acquire the target company. Selling the crown jewels: sale of valuable assets to make the firm less attractive. Leveraged buyout: managers and investors purchase controlling interests and take the firm private.

Business Combinations: Why?
Operating synergies Competitiveness in the international marketplace Financial synergy Diversification Divestitures ? ? ? ? ?

Business Combinations: Why Not?
Insufficient management control over the resulting conglomerate, resulting in future divestitures. Business combinations may enable suboptimal allocation of capital. Accounting method may encourage firms to pay too much.

Business Combinations: Historical Perspective
: horizontal integration : vertical integration 1945-present: merger mania 1970s: conglomerate mergers 1980s - present: strategic acquisitions

How it is accounted for:
Types of Combinations What is acquired: What is given up: How it is accounted for: Cash Purchase Method Net assets of S Company Debt Stock Pooling of Interests Method Common stock of S Company Combination of above

Stock Acquisition VS Asset Acquisition
must acquire 100% of target firm, hence higher cost need to negotiate with target management no separate legal entity Stock Acquisition may obtain control by acquiring 50% of voting common stock can avoid formal negotiation with target management maintain separate legal entity limited liability greater flexibility in filing tax returns regulations apply to one firm only

Statutory Consolidation
Types of Combinations Statutory Merger A Company A Company B Company + Statutory Consolidation C Company A Company B Company + Stock Acquisition Consolidated Financial Statements of A and B Companies Financial Statements of A Company Financial Statements of B Company +

Determining Price Price Stock exchange ratio
effect of acquisition on future earnings value of the firm’s identifiable net assets estimated value of implied goodwill Stock exchange ratio number of shares of acquiring company to be exchanged for each share of the acquired company

Determining Method of Payment
Cash or stock? Factors affecting method of payment: liquidity position of acquiring firm willingness of sellers to accept alternative forms of payment tax and accounting issues

Estimate Implied Goodwill
By discounting expected future excess earnings identify normal rate of return for similar firms apply rate of return to net assets of target firm to estimate normal earnings estimate expected future earnings of target excess earnings = expected normal earnings earnings goodwill = discounted value of excess earnings -

Chapter 2: Methods of Accounting for Business Combinations

Accounting Methods for Business Combinations
Purchase Method treats the combination as the purchase of one or more companies by another. Pooling of Interests Method treats the combination as two or more groups of stockholders uniting their ownership interests by an exchange of common stock.

Comparison of Purchase and Pooling of Interests
Assets and liabilities acquired are recorded at their fair values. Any excess of cost over fair value of net assets acquired is recorded as goodwill. Pooling of Interests Assets and liabilities are recorded at their precombination book values. No excess of cost over book value exists, and no new goodwill is recorded

The acquired company’s retained earnings are added into the acquiring company’s retained earnings. Equity shares issued are recorded at the book value of the acquired shares. Purchase The acquired company’s retained earnings are not added into the acquiring company’s retained earnings. Equity securities issued are recorded at their fair market value.

There is no additional depreciation or amortization expense. The issuer and combiner companies’ earnings are combined for the full fiscal year in which the combination occurs. Purchase The excess of cost over book value is depreciated or amortized to reduce future earnings. The acquired company’s earnings are included with the acquiring firm’s only from the date of combination forward.

Direct costs are capitalized as part of the acquisition cost. Indirect costs are expensed. Security issuance costs are deducted from additional paid-in capital. Pooling of Interests Direct costs are expensed in the year in which incurred. Indirect costs are expensed. Security issuance costs are expensed.

Acquisition Costs - An Illustration
Facts: SMC Company acquires 100% of the net assets of Bee Company by issuing shares of common stock with a fair value of $120,000. SMC incurred: $1,500 of accounting and consulting costs $3,000 of stock issue costs $2,000 monthly overhead cost for its mergers department

Acquisition Costs - An Illustration
Pooling Accounting: Accounting and Consulting Expense (Direct) 1,500 Merger Department Expense (Indirect) 2,000 Securities Issue Expense (Security Issue Costs) 3,000 Cash ,500 Purchase Accounting: Goodwill (Direct) 1,500 Merger Department Expense (Indirect) 2,000 Other Contributed Capital (Security Issue Costs) 3,000 Cash ,500

Disadvantages of Pooling Method
Values given and received are ignored in a negotiated transaction. “Instant earnings” can result from sale of newly pooled assets that are carried at their precombination low book values, and from including precombination earnings of other companies in the year of combination.

Disadvantages of Purchase Method
Subjective - appraisal of assets or stock values are necessary. Inconsistent - accounting for one part of the combined company on a fair value and the other part of a historical basis.

Financial statements “as if” the combination had been consummated.
Pro Forma Statements Financial statements “as if” the combination had been consummated. Functions provide information in the planning stages of the combination disclose relevant information subsequent to the combination

Disclosure Requirements
Purchase Method notes to financial statements should include pro forma information in the year of combination in the immediately preceding period if comparative financial statements are presented

Disclosure Requirements
Pooling Method financial statements should be restated on a pro forma basis for all years presented notes to financial statements should include disclosure that the statements of previously separately firms have been combined operating results of separate firms prior to the combination

Purchase Example - Facts
On January 1, 2000, P Company acquired the assets and assumed the liabilities of S Company. P Company gave one of its $15 par value common shares for each share of S company common stock. P Company common stock has a fair value per share of $48. Refer to Illustration 2-4 for the companies balance sheet information.

Purchase Example - Journal Entry
Cash and Receivables ,000 Inventories ,000 Land ,000 Buildings & Equipment (Net) 1,000,000 Discount on Bonds Payable ,000 Goodwill ,000 Current Liabilities ,000 Bonds Payable ,000 Common Stock ,000 Other Contributed Capital 990,000 Identifiable net assets acquired are recorded at their market value on the acquisition date Goodwill = excess cost over fair value of identifiable assets acquired Common stock issued is recorded at market value on the acquisition date

Equity Allocation in Pooling of Interests - Case A
P issued shares with par value of $450,000 Other Contributed Capital - S $50,000 Retained Earnings - S $140,000 Common stock -S $300,000 $300,000 $50,000 $140,000 Common Stock - P $750,000 Other Contributed Capital - P $400,000 Retained Earnings - P $350,000 $100,000

Journal Entry - Case A Cash and Receivables 180,000
net assets acquired are carried forward at their book value Cash and Receivables ,000 Inventories ,000 Land ,000 Buildings & Equipment ,000 Other Contributed Capital ,000 Accumulated Depreciation 300,000 Current Liabilities ,000 Bonds Payable ,000 Common Stock ,000 Retained Earnings ,000 Total shareholders’ equity of S Company ($490,000) is carried forward to P Company Par value of common stock issued is recorded

Equity Allocation in Pooling of Interests - Case B
P issued shares with par value of $800,000 Other Contributed Capital - S $50,000 Retained Earnings - S $140,000 Common stock -S $300,000 $50,000 $50,000 $300,000 $90,000 Common Stock - P $750,000 Other Contributed Capital - P $400,000 Retained Earnings - P $350,000 $400,000

Journal Entry - Case B Cash and Receivables 180,000
net assets acquired are carried forward at their book value Cash and Receivables ,000 Inventories ,000 Land ,000 Buildings & Equipment ,000 Other Contributed Capital ,000 Accumulated Depreciation 300,000 Current Liabilities ,000 Bonds Payable ,000 Common Stock ,000 Retained Earnings ,000 Total shareholders’ equity of S Company ($490,000) is carried forward to P Company Par value of common stock issued is recorded

Equity Allocation in Pooling of Interests - Case C
P issued shares with par value of $330,000 Other Contributed Capital - S $50,000 Retained Earnings - S $140,000 Common stock -S $300,000 $30,000 $20,000 $300,000 $140,000 Common Stock - P $750,000 Other Contributed Capital - P $400,000 Retained Earnings - P $350,000

Journal Entry - Case C Cash and Receivables 180,000
net assets acquired are carried forward at their book value Cash and Receivables ,000 Inventories ,000 Land ,000 Buildings & Equipment ,000 Accumulated Depreciation 300,000 Current Liabilities ,000 Bonds Payable ,000 Common Stock ,000 Other Contributed Capital ,000 Retained Earnings ,000 Total shareholders’ equity of S Company ($490,000) is carried forward to P Company Par value of common stock issued is recorded

Equity Allocation in Pooling of Interests - Case D
P issued shares with par value of $275,000 Other Contributed Capital - S $50,000 Retained Earnings - S $140,000 Common stock -S $300,000 $25,000 $50,000 $275,000 $140,000 Common Stock - P $750,000 Other Contributed Capital - P $400,000 Retained Earnings - P $350,000

Pooling Example - Case D
net assets acquired are carried forward at their book value Cash and Receivables ,000 Inventories ,000 Land ,000 Buildings & Equipment ,000 Accumulated Depreciation 300,000 Current Liabilities ,000 Bonds Payable ,000 Common Stock ,000 Other Contributed Capital ,000 Retained Earnings ,000 Total shareholders’ equity of S Company ($490,000) is carried forward to P Company Par value of common stock issued is recorded

Valuation of Net Assets Acquired:
Bargain Purchase Bargain = Fair value of identifiable net assets acquired Less: Purchase price Valuation of Net Assets Acquired: Current assets, long-term investments in marketable securities, liabilities = fair value Previously recorded goodwill = 0 Long-term assets = fair value - bargain allocation (The bargain is allocated to long-term assets in proportion to their fair value.) Any remaining bargain is recorded as negative goodwill and amortized over a maximum of 40 years.

Bargain Purchase - Example
Bargain = Fair value of identifiable net assets ($23,000) Purchase price ($17,000) = $6,000 Building $4,500 Land $1,500 Current Assets ,000 Buildings ($15,000-$4,500) 10,500 Land ($5,000-$1,500) ,500 Liabilities ,000 Cash ,000 Building and Land is recorded at fair value minus allocated bargain Current assets and liabilities are recorded at fair value

Contingent Considerations
Contingencies based on earnings Contingencies based on security prices

Earnings Contingency Definition Accounting Treatment
additional consideration to be made if the combined company’s future earnings equal or exceed a threshold. Accounting Treatment as additional cost of acquisition

Stock Price Contingency
Definition additional consideration to be made if the future market value of shares issued is less than the guaranteed value Accounting Treatment no effect on acquisition cost as an adjustment to Other Contributed Capital

Leveraged Buyout (LBO)
A management group contributes stock they hold and borrows funds to a create new company, which acquires all the outstanding common shares of their employer company.

Borrowed Fund Stock of employer company held by managers New Company acquires Employer Company

Valuation of New Company net assets acquired by borrowed fund market value net assets contributed by managers book value

Leveraged Buyout (LBO) Example
Valuation of Net Assets in New Company Excess of cost over book value Market Value Excess cost applied to plant assets = $13,500 Goodwill $9,000 Book Value $1,000 $9,000 10% 90% Net assets contributed by managers Net assets acquired by borrowed fund of $31,500

Criteria for Pooling of Interests
Company Attributes autonomous of any other companies independent of other combining companies

Exchange of Stock single transaction common stock for 90% common stock no change in equity interest no abnormal treasury stock transactions same ratio of interest of individual stockholders voting rights immediately exercisable no provision for future issuance of stock

Absence of Planned Transactions no agreement to reacquire stock no financial arrangements for shareholders no unusual disposal of assets

Chapter 3: Consolidated Financial Statements - Date of Acquisition

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 ,000 Cash ,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 ,000 Cash ,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 ,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 ,000 Cash ,000 Computation and Allocation of Difference between Cost and Book Value Cost of Investment ,000 - Book Value of Equity Acquired (80,000 x90%) 72,000 = Difference between Cost and Book Value

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 ,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 ,000 Cash ,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 ,000 The Allocation Eliminating Entry Land ,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 ,000 Cash ,000 Computation and Allocation of Difference between Cost and Book Value Cost of Investment ,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

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 ,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 ,750 Difference between Cost and Book Value 16, 250 Investment in S Company ,000 Treasury Stock ,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 ,000 Receivable/Payable Accounts Payable (to S) 100,000 Accounts Receivable (from P) ,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

Chapter 4: Consolidated Financial Statements after Acquisition

Accounting for Investments

Accounting Methods for Investments
Cost Method The investment account is adjusted only when additional shares are purchased or sold Partial Equity Method The investment account is adjusted for the investor’s share of investee income and dividends Complete Equity Method Additional adjustments are made for unrealized intercompany profit and amortization of purchase differential

Cost Method Investment Related Accounts of Parent Investment in S
Dividend Income Share of dividends declared of S Liquidating dividend Acquisition Cost

Partial Equity Method Investment Related Accounts of Parent
Investment in S Equity in subsidiary income Acquisition Cost Share of dividends declared Equity in subsidiary loss Equity in subsidiary income Equity in subsidiary income Equity in subsidiary loss

Complete Equity Method
Investment Related Accounts of Parent Investment in S Equity in subsidiary income Acquisition Cost Share of dividends declared Equity in subsidiary loss Equity in subsidiary income Equity in subsidiary income Equity in subsidiary loss Amortization of goodwill

Cost Method - Eliminating Entries (EE) Year of Acquisition
The Investment Entry Common Stock - S Company 80,000 Other Contributed Capital - S Company 40,000 1/1 Retained Earnings - S Company 32,000 Difference between cost and book value 13,000 Investment in S Company ,000 Note: eliminate beginning retained earnings of the subsidiary This entry is the same as the investment entry on the acquisition date (true for the first year only)

The Differential Entry Land ,000 Difference between cost and book value ,000 To allocate the differential between cost and book value to the appropriate account(s) This entry is the same as the differential entry on the acquisition date

The Dividend Entry Dividend income - P 8,000 Dividends declared - S 8,000 To eliminate the contra-equity account of the subsidiary To avoid double counting of income

Noncontrolling Interest in Income
Reported income of S + - Adjustments Adjusted NI of S x Noncontrolling % Noncontrolling interest in income

Controlling Interest in Income
Reported income of P + - Adjustments (Adjusted NI of S) x (P %) + Controlling interest in income

Consolidated Retained Earnings
Reported R/E of P + Consolidated NI - Dividends declared of P Consolidated R/E

Cost Method EE’s After Year of Acquisition
The Reciprocal Entry Investment in S Company 16,000 1/1 Retained Earnings - P Company ,000 Adjust the investment account to equal the amount it would have under equity method Adjust P’s reported beginning R/E to equal beginning consolidated R/E Other Entries (similar to the first year EE)

Equity Method EE’s Year of Acquisition
The Income Entry Equity in subsidiary income 24,000 Investment in S Company ,000 (To eliminate equity in net income included in reported NI of P) The Dividend Entry Investment in S Company 8,000 Dividends declared ,000 (To eliminate intercompany dividend) These two entries return the investment account to its beginning balance, to be matched against the subsidiary’s beginning R/E in the next EE.

Equity Method EE’s Year of Acquisition
The Investment Entry Common Stock - S Company 80,000 Other Contributed Capital - S Company 40,000 1/1 Retained Earnings - S Company 32,000 Difference between cost and book value 13,000 Investment in S Company ,000 Note: eliminate beginning R/E of the subsidiary The Differential Entry Land ,000 Difference between cost and book value 13,000 To allocate the differential between cost and BV to the appropriate account(s)

More on Eliminating Entries
Equity Method EE’s After Year of Acquisition Similar to entries in the year of acquisition Intercompany revenue and expenses Interest revenue 8,000 Interest expense 8,000

Included in consolidated NI
Interim Acquisitions Accounting under the purchase method Revenues and expenses of the subsidiary are included with those of parent only from the date of acquisition forward Beginning of S fiscal yr. Acquisition date End of S fiscal yr. Not included in consolidated NI Included in consolidated NI Net income of S

Interim Acquisitions Full Year Reporting
Consolidated Income Statement Revenues and expenses of P Post- acquisition revenues and expenses of S Pre- acquisition revenues and expenses of S Post- acquisition revenues and expenses of S plus + minus Pre-acquisition NI amount of S Noncontrolling interest in income minus Consolidated Net Income

Interim Acquisitions Partial Year Reporting
Consolidated Income Statement Revenues and expenses of P Post- acquisition revenues and expenses of S plus + Noncontrolling interest in income minus Consolidated Net Income

Consolidated Statement of Cash Flows
Purpose to reflect all cash outlays and inflows of the consolidated entity except those between parent and subsidiary

Procedure derived from consolidated income statement beginning and ending consolidated balance sheets similar to unconsolidated firm, except: noncontrolling interests in combined income subsidiary dividends parent acquisition of additional subsidiary shares

Cash inflow from operating activities indirect method: add back noncontrolling interest in combined income Cash outflow from financing activities includes subsidiary dividends to noncontrolling shareholders Cash outflow from investing activities excludes parent’s acquisition of additional subsidiary shares directly from subsidiary includes parent’s acquisition of additional subsidiary shares in open market

Effect of method of payment in an acquisition cash acquisition: cash spent or received is included in the investing activity section of the cash flow statement stock acquisition: issuance of stock or debt is reported in the notes to the financial statements

Chapter 5: Allocation, Depreciation, and Amortization of the Difference between Cost and Book Value

Allocation of Purchase Differential
Book value of net assets acquired Acquisition cost (MV-BV) of identifiable net assets Purchase differential Goodwill (if amount >0) or bargain purchase (if amount <0)

Allocation of Purchase Differential: An Alternative View
Book value of net assets acquired Market value of net assets acquired Acquisition cost (MV-BV) of identifiable net assets Goodwill (if amount >0) or bargain purchase (if amount <0) Goodwill (if amount >0) or bargain purchase (if amount <0)

Valuation of Net Assets Acquired:
Bargain Purchase Valuation of Net Assets Acquired: Current assets, long-term investments in marketable securities, liabilities = fair value Previously recorded goodwill = 0 Long-term assets = fair value - bargain allocation (The bargain is allocated to long-term assets in proportion to their fair value.) Any remaining bargain is recorded as negative goodwill and amortized over a maximum of 40 years.

Case 1: Positive Goodwill
Wholly Owned Subsidiary Book value of net assets acquired $2,000,000 Acquisition cost $2,750,000 Inventory $50,000 Equipment $300,000 Purchase differential $750,000 Land $150,000 Goodwill $250,000

Case 1: Positive Goodwill
80% Owned Subsidiary Book value of net assets acquired $1,600,000 Note: identifiable net assets are written up only by : P% x (MV-BV) Acquisition cost $2,200,000 Inventory $40,000 Equipment $240,000 Purchase differential $600,000 Land $120,000 Goodwill $200,000

Case 1: Positive Goodwill - EE’s
The Investment Entry Retained earnings - S ,000 Capital stock - S ,200,000 Difference between cost and book value 600,000 Investment in S ,200,000 The Allocation Entry Inventory ,000 Equipment ,000 Land ,000 Goodwill ,000 Difference between cost and book value ,000

Case 2A: Bargain Purchase BV < Cost
80% Owned Subsidiary Book value of net assets acquired $1,600,000 Note: identifiable net assets are written up only by : P% x (MV-BV) Acquisition cost $1,900,000 Inventory $40,000 Equipment $240,000 Purchase differential $300,000 Land $120,000 Bargain purchase $100,000

Case 2A: Bargain Purchase BV < Cost
Allocation of Bargain Purchase Note: assets are reduced in proportion to their fair values, not book values Reduction in asset amounts: Equipment $30,000 Land $20,000 Bargain purchase $100,000 Other noncurrent assets $50,000

Case 2A: Bargain Purchase BV < Cost : EE’s
The Investment Entry Retained earnings - S ,000 Capital stock - S ,200,000 Difference between cost and book value 300,000 Investment in S ,900,000 The Allocation Entry Inventory ,000 Equipment (240,000-30,000) ,000 Land (120,000-20,000) ,000 Other noncurrent assets (0-50,000) ,000 Difference between cost and book value ,000

Case 2B: Bargain Purchase BV > Cost
80% Owned Subsidiary Book value of net assets acquired $1,600,000 Note: identifiable net assets are written up only by : P% x (MV-BV) Acquisition cost $1,500,000 Inventory $40,000 Equipment $240,000 Purchase differential -$100,000 Land $120,000 Bargain purchase $500,000

Case 2B: Bargain Purchase BV > Cost
Allocation of Bargain Purchase Note: assets are reduced in proportion to their fair values, not book values Reduction in asset amounts: Equipment $150,000 Bargain purchase $500,000 Land $100,000 Other noncurrent assets $250,000

Case 2B: Bargain Purchase BV > Cost : EE’s
The Investment Entry Retained earnings - S ,000 Capital stock - S ,200,000 Difference between cost and book value ,000 Investment in S ,500,000 The Allocation Entry Difference between cost and book value 100,000 Inventory ,000 Equipment (240, ,000) ,000 Land (120, ,000) ,000 Other noncurrent assets (0-250,000) ,000

Amortization of Purchase Differential
Case 1: Positive Goodwill, 80% Owned Subsidiary Purchase differential Annual adjustments to consolidated NI 2001 Inventory $40,000 Inventory $40,000 Inventory $40,000 Inventory $40,000 Inventory $40,000 COGS $40,000 Inventory $40,000 Inventory $40,000 Depreciation expense $24,000 Equipment $240,000 Depreciation expense $24,000 Land $120,000 Goodwill $200,000 Amortization expense $10,000 Amortization expense $10,000 Amortization expense $10,000

Amortization of Purchase Differential
Case 1: Positive Goodwill, 80% Owned Subsidiary Annual adjustments to beginning consolidated R/E 2001 2001 2002 COGS $40,000 Depreciation expense $24,000 Depreciation expense $24,000 Consolidated NI adjustments Depreciation expense $24,000 Amortization expense $10,000 Amortization expense $10,000 Amortization expense $10,000 Adjustments to 1/1 R/E = sum of NI adjustments in all previous years 74,000 108,000

The Allocation EE Cost Method
End of Year of Acquisition Cost of goods sold ,000 Depreciation expense ,000 Amortization expense of goodwill 10,000 Equipment ,000 Land ,000 Goodwill ,000 Difference between cost and book value ,000 Add up to $74,000, becomes the 1/1 R/E adjustment in the next year (see next slide)

Year Subsequent to Acquisition Beginning retained earnings ,000 Depreciation expense ,000 Amortization expense of goodwill 10,000 Equipment ,000 Land ,000 Goodwill ,000 Difference between cost and book value ,000 Add up to $108,000, becomes the 1/1 R/E adjustment in the next year (see next slide)

2 Years Subsequent to Acquisition Beginning retained earnings 108,000 Depreciation expense ,000 Amortization expense of goodwill 10,000 Equipment ,000 Land ,000 Goodwill ,000 Difference between cost and book value ,000

The Allocation EE Partial Equity Method

The Allocation EE Partial Equity Method
Year Subsequent to Acquisition Beginning retained earnings ,000 Depreciation expense ,000 Amortization expense of goodwill 10,000 Equipment ,000 Land ,000 Goodwill ,000 Difference between cost and book value ,000 Add up to $108,000, becomes the 1/1 R/E adjustment in the next year (see next slide)

The Allocation EE Complete Equity Method

The Allocation EE Complete Equity Method
Year Subsequent to Acquisition Investment in S ,000 Depreciation expense ,000 Amortization expense of goodwill 10,000 Equipment ,000 Land ,000 Goodwill ,000 Difference between cost and book value ,000 Add up to $108,000, becomes the 1/1 R/E adjustment in the next year (see next slide) Note: The investment account, instead of the beginning R/E, is adjusted under the complete equity method

Push Down Accounting Definition
A subsidiary changes the accounting basis in its separate financial statements based on the purchase price paid by the parent for its stock.

Push Down Accounting Yes No Yes No Push down accounting should
not be used Yes S has outstanding public debt? No Yes S has outstanding senior class of capital stock? Push down accounting is recommended No <80% What is P’s % of ownership? 80-95% Push down accounting is required <80%

Chapter 6: Elimination of Unrealized Profit on Intercompany Sales of Inventory

Intercompany Sales of Inventory
Parent Company Downstream Sale Upstream Sale Subsidiary Subsidiary Horizontal Sale obj 1

Financial Reporting Objectives
Consolidated sales = sales with parties outside the affiliated group Consolidated COGS = cost to the affiliated group of goods that have been sold to outside parties Consolidated inventory = inventory at its cost to the affiliated group obj 1

To present consolidated balances of sales, cost of sales, and inventory as if the intercompany sale had never occurred. obj 1

Downstream Sales : No Unrealized Profit
Outsider Supplier Parent Company Purchased for $200,000 Sold for $250,000 Sold for $270,000 Subsidiary Outside Customer obj 2

Downstream Sales No Unrealized Profit - EE
Purchases ,000 To eliminate intercompany purchase that the subsidiary has recorded To eliminate intercompany sale that the parent has recorded obj 2

Downstream Sales: Unrealized Profit in Ending Inventory
Outsider Supplier Parent Company Purchased for $200,000 Sold for $250,000 Note: it is the parent who records the intercompany profit, thus the parent’s income needs to be adjusted in consolidation Sold 60% of goods Subsidiary Outside Customer obj 2

Downstream Sales - EE Year of Intercompany Sale
Purchases ,000 Ending Inventory - Inc. state. (COGS) 20,000 Inventory - balance sheet 20,000 To eliminate intercompany sale and purchases To exclude the unrealized profit from consolidated net income To exclude the unrealized profit from ending inventory obj 2

Downstream Sales - EE Year after Intercompany Sale
Cost or Partial Equity Methods Beginning R/E - P ,000 Beginning Inventory - Inc. State. (Cost of sales) ,000 The intercompany profit in beginning inventory is excluded from last year’s consolidated NI, hence this year’s 1/1 R/E To include the intercompany profit in beginning inventory, which is realized in the current year obj 2

Downstream Sales - EE Year after Intercompany Sale
Complete Equity Method Investment in S ,000 Beginning Inventory - Inc. State. (Cost of sales) ,000 The intercompany profit in beginning inventory is excluded from last year’s consolidated NI, hence the investment account To include the intercompany profit in beginning inventory, which is realized in the current year obj 2

Amount of Intercompany Profit
Gross profit method intercompany profit that should be eliminated = ending inventory of buying affiliate x selling affiliate’s gross profit rate (i.e., gross profit / cost) obj 2

Elimination of Downstream Intercompany Profit
eliminate the parent’s and the noncontrolling stockholders’ portion of intercompany profit despite partial ownership of the parent required by current GAAP Partial elimination eliminate only the parent’s portion of intercompany profit obj 3

Upstream Sales Outsider Supplier Subsidiary Parent Outside Company
Purchase Intercompany Sale Note: it is the subsidiary who records the intercompany profit, thus the subsidiary’s income needs to be adjusted in consolidation Parent Company Outside Customer Sell obj 4

Upstream Sales An Example
Parent Company $400,000 intercompany merchandise in ending inventory 80% owned Subsidiary Profit margin = 25% x selling price Total sales $700,000 obj 4, 5

Upstream Sales Cost or Partial Equity Methods
Year of Intercompany Sale - EE’s Sales ,000 Purchases ,000 Ending Inventory - Inc. state. (COGS) ,000 Inventory - balance sheet ,000 To eliminate intercompany sale and purchases To exclude the unrealized profit (400,000x25%) from consolidated net income To exclude the unrealized profit from ending inventory obj 4, 5

Upstream Sales - EE Cost or Partial Equity Methods
Year after Intercompany Sale - EE’s Parent’s share of unrealized profit in beginning inventory Beginning R/E - P ($100,000x80%) ,000 Beginning R/E - S ($100,000x20%) ,000 Beginning Inventory - Inc. State. (Cost of sales) ,000 To include the intercompany profit in beginning inventory, which is realized in the current year Noncontrolling interests’ share of unrealized profit in beginning inventory obj 4, 5

Cost or Partial Equity Methods
Noncontrolling Interest in Income Reported income of S Upstream-sale profit in ending inventory Upstream-sale profit in beginning inventory Adjusted NI of S x Noncontrolling % Noncontrolling interest in income obj 4, 5

Cost and Partial Equity Methods
Controlling Interest in Income Downstream-sale profit in ending inventory Reported income of P Downstream-sale profit in beginning inventory Amortization of purchase differential (Adjusted NI of S) x (P %) Consolidated income obj 4, 5

Cost and Partial Equity Methods
Consolidated Retained Earnings P% x (Upstream-sale profit in P’s ending inventory) Reported R/E of P Downstream-sale profit in S’s ending inventory P’s share of increase in S R/E since acquisition Accumulative amortization of purchase differential Consolidated R/E obj 4, 5

Upstream Sales Complete Equity Method
Year of Intercompany Sales - Journal Entries Equity in subsidiary income ,000 Investment in S ,000 To exclude the unrealized profit (400,000x25%) from equity in subsidiary income obj 4, 5

Year after Intercompany Sales - Journal Entries Investment in S ,000 Equity in subsidiary net income 80,000 To include in equity in subsidiary income the intercompany profit, which is realized in the current year obj 4, 5

Year of Intercompany Sales - EE’s Sales ,000 Purchases ,000 Ending Inventory - Income Statement 100,000 Inventory - Balance Sheet ,000 To eliminate intercompany sale and purchases To exclude the unrealized profit (400,000x25%) from equity in subsidiary income obj 4, 5

Year after Intercompany Sale - EE Parent’s share of unrealized profit in beginning inventory Investment in S ,000 Beginning retained earnings - S 20,000 1/1 Inventory - Income Statement ,000 To include the intercompany profit in beginning inventory, which is realized in the current year Noncontrolling interests’ share of unrealized profit in beginning inventory obj 4, 5

Consolidated net income = Reported net income of Parent Consolidated retained earnings = Reported retained earnings of Parent obj 4, 5

Preaffiliation Profit Should We Eliminate?
GAAP is silent as to elimination of preaffiliation profit. If selling company is the subsidiary, the retained earning is eliminated in consolidation. If selling company is the parent, elimination would cause double counting of profit. obj 7

Chapter 7: Elimination of Unrealized Gains or Losses on Intercompany Sales of Property and Equipment

Intercompany Sales of Land (Nondepreciable Property)
Parent Company Land Downstream Sale Upstream Sale Subsidiary

To defer unrealized intercompany gains or losses until such property is sold to parties outside the affiliated group To present such property in the consolidated balance sheet at its cost to the affiliated group

Upstream Sales - Land An Example
Parent Company Sells land for $500,000 Sells to outside party for $550,000 years later Purchased land for $300,000 80% owned Subsidiary S records gain on sale of land of $200,000

Upstream Sales - Land Cost and Partial Equity Methods
Year of Intercompany Sale - EE Gain on sale of land 200,000 Land ,000 To reduce the land to its historical cost paid by the selling affiliate To exclude the unrealized gain from consolidated net income

Years after Intercompany Sale - EE Parent’s share of the unrealized gain Beginning R/E - P ($200,000 x 80%) ,000 Beginning R/E - S ($200,000 x 20%) ,000 Land ,000 To reduce the land to its historical cost paid by the selling affiliate Noncontrolling interests’ share of the unrealized gain

Year of Sale to Outside Party - EE Parent’s share of the unrealized gain Beginning R/E - P ($200,000 x 80%) ,000 Beginning R/E - S ($200,000 x 20%) ,000 Gain on sale of land ,000 To record intercompany gain on sale of land, which is realized in the current year Noncontrolling interests’ share of the unrealized gain

Upstream Sales - Land Complete Equity Method
Year of Intercompany Sales - Journal Entry Equity in subsidiary income ,000 Investment in S ,000 To exclude the parent’s share of the unrealized gain from equity in subsidiary income

Year of Intercompany Sale - EE Gain on sale of land 200,000 Land ,000 To reduce the land to its historical cost paid by the selling affiliate To exclude the unrealized gain from consolidated net income

Years after Intercompany Sale - EE Parent’s share of the unrealized gain Investment in S ,000 Beginning retained earnings - S ,000 Land ,000 To reduce the land to its historical cost paid by the selling affiliate Noncontrolling interests’ share of the unrealized gain

Year of Sale to Outside Party - EE Parent’s share of the unrealized gain Investment in S ,000 Beginning retained earnings - S ,000 Gain on sale of land ,000 To record intercompany gain on sale of land, which is realized in the current year Noncontrolling interests’ share of the unrealized gain

Intercompany Sales Depreciable Property
Parent Company Machinery, Equipment or Building Downstream Sale Upstream Sale Subsidiary

To defer unrealized intercompany gains or losses until such property is sold to parties outside the affiliated group To present the depreciable property and related accounts (accumulated depreciation and depreciation expense) in the consolidated balance sheet based on its historical cost to the affiliated group

Downstream Sales - Equipment An Example
Sold on 1/1/2002 for $900,000 90% owned Subsidiary Parent Company Purchased equipment for $1,350,000 Parent has recorded $600,000 Acc. Dep. On the equipment Equipment has remaining useful life of 3 years Note: it is the parent who records the intercompany profit, thus the parent’s income needs to be adjusted in consolidation

Downstream Sales - Equipment All Methods
Year of Intercompany Sale To restore the equipment to its historical cost The Equipment EE Equipment (1,350, ,000) 450,000 Gain on sale of equipment 150,000 Accumulated depreciation ,000 To restore the accumulated depreciation to its balance on the date of intercompany sale To eliminate the unrealized gain

Downstream Sales - Equipment All Methods
Year of Intercompany Sale The Depreciation EE Accumulated Depreciation 50,000 Depreciation Expense 50,000 To adjust depreciation expense from the recorded amount to the amount based on the original historical cost of equipment

Downstream Sales - Equipment Cost or Partial Equity Methods
Years after Intercompany Sale To restore the equipment to its historical cost The Equipment EE Equipment (1,350, ,000) 450,000 Beginning retained earnings - P 150,000 Accumulated depreciation ,000 To restore the accumulated depreciation to its balance on the date of intercompany sale To eliminate the unrealized gain

Downstream Sales - Equipment Cost or Partial Equity Methods
Years after Intercompany Sale The Depreciation EE Accumulated Depreciation 100,000 Beginning retained earnings - P ,000 Depreciation Expense 50,000 Adjustment to prior years’ depreciation expense Adjustment to current year’s depreciation expense

Downstream Sales - Equipment Complete Equity Methods
Years after Intercompany Sale To restore the equipment to its historical cost The Equipment EE Equipment (1,350, ,000) 450,000 Investment in S 150,000 Accumulated depreciation ,000 To restore the accumulated depreciation to its balance on the date of intercompany sale To eliminate the unrealized gain from the investment account

Downstream Sales - Equipment Complete Equity Methods
Years after Intercompany Sale The Depreciation EE Accumulated Depreciation 100,000 Investment in S ,000 Depreciation Expense 50,000 Adjustment to prior years’ depreciation expense Adjustment to current year’s depreciation expense

Upstream Sales - Equipment An Example
Sold on 1/1/2002 for $600,000 Parent Company 90% owned Subsidiary Purchased equipment for $800,000 Subsidiary has recorded $300,000 Acc. Dep. on the equipment Equipment has remaining useful life of 5 years Note: it is the subsidiary who records the intercompany profit, thus the subsidiary’s income needs to be adjusted in consolidation

Upstream Sales - Equipment Cost and Partial Equity Methods
Year of Intercompany Sale To restore the equipment to its historical cost The Equipment EE Equipment (1,350, ,000) 450,000 Gain on sale of equipment 150,000 Accumulated depreciation ,000 To restore the accumulated depreciation to its balance on the date of intercompany sale To eliminate the unrealized gain

Year of Intercompany Sale The Depreciation EE Accumulated Depreciation 50,000 Depreciation Expense 50,000 To adjust depreciation expense from the recorded amount to the amount based on the original historical cost of equipment

Years after Intercompany Sale To eliminate the parent’s and noncontrolling interests’ shares of unrealized gain recorded in prior years The Equipment EE Beginning retained earnings - P ,000 Beginning retained earnings - S 15,000 Equipment (800, ,000) 200,000 Accumulated depreciation ,000 To restore the equipment to its historical cost To restore the accumulated depreciation to its balance on the date of intercompany sale

Years after Intercompany Sale The Depreciation EE Accumulated Depreciation 40,000 Depreciation Expense ,000 Beginning retained earnings - P ,000 Beginning retained earnings - P ,000 Adjustment to prior years’ depreciation expense Adjustment to current year’s depreciation expense

Disposal of Equipment by Purchasing Affiliate The Disposal EE Beginning retained earnings - P ,000 Beginning retained earnings - S ,000 Gain on sale of equipment ,000 i To include the intercompany profit, which is realized in the current year, in consolidated NI

Noncontrolling Interest in Income Reported income of S Unrealized gain on upstream-sale of equipment Depreciation adjustment (gain realized through usage) Upstream-sale unrealized profit in ending inventory Upstream-sale realized profit in beginning inventory Adjusted NI of S x Noncontrolling % Noncontrolling interest in income

Controlling Interest in Income Downstream-sale profit in ending inventory Reported income of P Downstream-sale realized profit in beginning inventory Unrealized gain on downstream-sale of equipment Depreciation adjustment (gain realized through usage) Amortization of purchase differential (Adjusted NI of S) x (P %) Consolidated income

Consolidated Retained Earnings P% x (Upstream-sale profit in P’s ending inventory) Reported R/E of P Downstream-sale profit in S’s ending inventory P’s share of increase in S R/E since acquisition P% x (Unrealized gain on upstream-sale of equipment) Unrealized gain on downstream sale of equipment Accumulative amortization of purchase differential Consolidated R/E

Downstream Sales - Equipment Complete Equity Method
Year of Intercompany Sale - JE The Gain JE: Equity in subsidiary income 85,000 Investment in S ,000 to adjust subsidiary income downward for the unrealized gain on sale of equipment The Depreciation JE: Investment in S 17,000 Equity in subsidiary income 17,000 to adjust subsidiary income upward for the gain realized through usage

Year of Intercompany Sale - EE To restore the equipment to its historical cost The Equipment EE Equipment ,000 Gain on sale of equipment 200,000 Accumulated depreciation ,000 To restore the accumulated depreciation to its balance on the date of intercompany sale To eliminate the unrealized gain

Year of Intercompany Sale - EE The Depreciation EE Accumulated Depreciation 250,000 Depreciation Expense 20,000 To adjust depreciation expense from the recorded amount to the amount based on the original historical cost of equipment

Downstream Sales - EE Complete Equity Method
Years after Intercompany Sale - EE To eliminate the unrealized gain from the investment account and 1/1 R/E - S The Equipment EE Investment in S ,000 Beginning retained earnings - S 15,000 Equipment ,000 Accumulated depreciation ,000 To restore the accumulated depreciation to its balance on the date of intercompany sale To restore the equipment to its historical cost

Years after Intercompany Sale - EE The Depreciation EE Accumulated Depreciation ,000 Investment in S ,000 Beginning retained earnings - S 3,000 Depreciation Expense 20,000 Adjustment to prior years’ depreciation expense Adjustment to current year’s depreciation expense

Disposal of Equipment by Purchasing Affiliate The Disposal JE: Investment in S 51,000 Equity in subsidiary income 51,000 To adjust subsidiary income upward for the realized intercompany gain on sale of equipment

Disposal of Equipment by Purchasing Affiliate The Disposal EE Investment in S ,000 Beginning retained earnings - S ,000 Gain on sale of equipment ,000 i To include the intercompany profit, which is realized in the current year, in consolidated NI

Chapter 8: Changes in Ownership Interest

Changes in Ownership - Transactions
parent’s transactions: parent purchases shares of subsidiary in the open market parent sells shares of subsidiary in the open market

Changes in Ownership - Transactions
subsidiary’s transactions: subsidiary issues new or treasury shares subsidiary buys treasury stock

Changes in Ownership

Parent’s % of ownership will:
Changes in Ownership Parent’s % of ownership will: Increase if P purchases additional shares of S in open market S issues stock, P acquires more than its pro-rata number of shares S buys treasury stock, P sells less than its pro-rata number of shares Decrease if P sells shares of S in open market S issues stock, P acquires less than its pro-rata number of shares S buys treasury stock, P sells more than its pro-rata number of shares

Accounting Treatment: the parent identifies for each step purchase
Step Purchases Transaction parent acquires subsidiary stock through several open market purchases Accounting Treatment: the parent identifies for each step purchase the cost of each investment, fair value of assets acquired, and the difference between cost and book value

Step Purchases An Example 1/1/2002 1/1/2003 1/1/2000 1/1/2001
15% shares acquired 75% shares acquired

Step Purchases An Example

Step sales - Cost Method
parent sells subsidiary stock through open market sales Accounting Treatment the parent identifies for each step sale: the carrying value of the investment sold, specific identification FIFO fair value of assets received, and gain or loss on the sale

Step Sales - Cost Method
An Example 1/1/2000 1/1/2001 1/1/2002 1/1/2003 7/1/2003 15% shares acquired 75% shares acquired 15% shares sold

In the Parent’s books: Assuming the parent uses specific identification

EE’s in the consolidation worksheet Gain on sale of investment 9,750 1/1 Retained earnings - P 9,750 To exclude the subsidiary undistributed income from acquisition to beginning of current year Gain on sale of investment 6,000 Subsidiary income sold 6,000 To exclude the subsidiary income from beginning of current year to sale date

Step Purchases - Partial Equity Method
In the Parent’s books: Investment in S 12,000 Retained earnings ,000 To restate the investment account from cost method (15% ownership) to partial equity method The amount = change in subsidiary R/E since first purchase x 15%

Issuance of Shares by Subsidiary To Parent Company Only
An Example 1/1/2001 1/1/2002 1/1/1993 P acquired 14,000 shares (70%) of S S issued 4,000 additional shares to P

Issuance of Shares by Subsidiary To Parent Company Only, Above BV
An Example *

Issuance of Shares by Subsidiary To Parent Company Only, Above BV
New shares issued above book value The purchase differential represents the transfer of interest from the parent to the noncontrolling stockholders Noncontrolling interests in net assets increase by $4,500.

Issuance of Shares by Subsidiary To Parent Company Only, Below BV
An Example *

Issuance of Shares by Subsidiary To Parent Company Only, Below BV
New shares issued below book value The purchase differential represents the transfer of interest from the noncontrolling stockholders to the parent Noncontrolling interests in net assets increase by $3,500.

Issuance of Shares by Subsidiary To Parent Company and Noncontrolling Stockholders
% owned remains the same BV of interest acquired = acquisition cost Purchase differential = 0 regardless of issue price of new shares

Issuance of Shares by Subsidiary To Noncontrolling Stockholders Only
An Example 1/1/2001 1/1/2002 1/1/1993 P acquired 14,000 shares (70%) of S S issued 4,000 additional shares to noncontrolling stockholders

Issuance of Shares by Subsidiary To Noncontrolling Stockholders Only
New shares issued above book value The purchase differential represent the transfer of interest from the noncontrolling stockholders to the parent Controlling interests in net assets increase by (purchase differential x P%)

Issuance of Shares by Subsidiary To Noncontrolling Stockholders Only, Above BV
In the parent’s books: Investment in S ,500 Gain from subsidiary issuance of shares 10,500 To record the transfer of interest from noncontrolling stockholders to the parent

Issuance of Shares by Subsidiary To Noncontrolling Stockholders Only, Below BV
In the parent’s books: Gain from subsidiary issuance of shares 8,167 Investment in S 8,167 To record the transfer of interest from the parent to noncontrolling stockholders

Purchase of Shares by Subsidiary To Noncontrolling Stockholders Only
Subsidiary purchases treasury shares above book value Controlling interest in net assets increases Accounting is analogous to issuance of shares by subsidiary

Chapter 9: Indirect Ownership and Reciprocal Stockholdings

Indirect Stockholdings
Father-son-grandson Affiliation Connecting Affiliation P P 90% 80% 90% S S R 80% 10% R

Reciprocal Stockholdings
90% S 90% 10% S 80% 10% R

Father-Son-Grandson Affiliation Cost Method
P P’s Interest in S is Acquired Prior to S’s Interest in R 90% 1/1/00 S 80% 1/1/01 R

Consolidated Net Income = $151,400

EE’s in the consolidation worksheet in Year 01 Investment in S ,000 1/1 Retained earnings - P 27,000 To establish reciprocity (change in R/E of S from acquisition date to beginning of current year) Dividend income ,000 Dividends declared - S ,000 Dividends declared - R ,000 To eliminate intercompany dividends

EE’s in the consolidation worksheet in Year 01 Common stock - R ($100,000 x 80%) 80,000 1/1 Retained earnings - R ($60,000 x 80%) 48,000 Difference between cost and book value 17,000 Investment in R ,000 To eliminate S’s investment in R Common stock - S ($200,000 x 90%) 180,000 1/1 Retained earnings - S ($100,000 x 90%) 90,000 Difference between cost and book value 52,000 Investment in S ,000 To eliminate P’s investment in S

P P’s Interest in S is Acquired Subsequent to S’s Interest in R 90% 1/1/01 S 80% 1/1/00 R

EE’s in the consolidation worksheet in Year 01 Investment in R 8,000 1/1 Retained earnings - S 8,000 To establish reciprocity for the investment by S in R Dividend income ,000 Dividends declared - S ,000 Dividends declared - R ,000 To eliminate intercompany dividends

EE’s in the consolidation worksheet in Year 01 Common stock - R ($100,000 x 80%) 80,000 1/1 Retained earnings - R ($60,000 x 80%) 48,000 Difference between cost and book value 25,000 Investment in R ,000 To eliminate S’s investment in R Common stock - S ($200,000 x 90%) 180,000 1/1 Retained earnings - S ($108,000 x 90%) 97,200 Difference between cost and book value 178,000 Investment in S ,000 To eliminate P’s investment in S

Connecting Affiliates Cost Method
P 70% 1/1/2000 90% 1/1/2000 S R 20% 1/1/2001

EE’s in the consolidation worksheet in Year 01 Investment in S ,000 1/1 Retained earnings - P 27,000 To establish reciprocity for the investment by P in S Investment in R 7,000 1/1 Retained earnings - P 7,000 To establish reciprocity for the investment by P in R

EE’s in the consolidation worksheet in Year 01 Dividend income ,000 Dividends declared - S ,000 Dividends declared - R ,000 To eliminate intercompany dividends Common stock - R ($100,000 x 20%) 20,000 1/1 Retained earnings - R ($60,000 x 20%) 12,000 Difference between cost and book value 3,000 Investment in R ,000 To eliminate S’s investment in R

EE’s in the consolidation worksheet in Year 01 Common stock - S ($200,000 x 90%) 180,000 1/1 Retained earnings - S ($100,000 x 90%) 90,000 Difference between cost and book value 52,000 Investment in S ,000 To eliminate P’s investment in S Common stock - R ($100,000 x 70%) 70,000 1/1 Retained earnings - R ($60,000 x 70%) 42,000 Difference between cost and book value 40,000 Investment in R ,000 To eliminate P’s investment in R

Connecting Affiliates Equity Method
P 70% 1/1/2000 90% 1/1/2000 S R 20% 1/1/2001

Equity Income and Dividend EE’s in Year 01 Equity in subsidiary income ($30,000 x 20%) 6,000 Dividends declared - R ($10,000 x 20%) 2,000 Investment in R ,000 To eliminate intercompany income and dividends for S’s investment in R Equity in subsidiary income ($30,000 x 70%) 21,000 Dividends declared - R ($10,000 x 70%) 7,000 Investment in R ,000 To eliminate intercompany income and dividends for P’s investment in R

Equity Income and Dividend EE’s in Year 01 Equity in subsidiary income ($54,000 x 90%) 48,600 Dividends declared - S ($20,000 x 90%) 18,000 Investment in S ,600 To eliminate intercompany income and dividends for P’s investment in S

Investment EE’s in Year 01 Common stock - R ($100,000 x 20%) 20,000 1/1 Retained earnings - R ($60,000 x 20%) 12,000 Difference between cost and book value 3,000 Investment in R ,000 To eliminate S’s investment in R Common stock - S ($200,000 x 90%) 180,000 1/1 Retained earnings - S ($100,000 x 90%) 90,000 Difference between cost and book value 52,000 Investment in S ,000 To eliminate P’s investment in S

EE’s in the consolidation worksheet in Year 01 Common stock - R ($100,000 x 70%) 70,000 1/1 Retained earnings - R ($60,000 x 70%) 42,000 Difference between cost and book value 40,000 Investment in R ,000 To eliminate P’s investment in R

Reciprocal Stockholdings
Accounting Methods Treasury stock approach treats the reciprocal stockholding as treasury stock on the consolidated balance sheet Mathematical approach gives explicit recognition to the effect of the reciprocal stockholding

Treasury Stock Approach Cost Method
90% 1/1/2001 10% 1/1/2001 S

Treasury Stock Approach
No reciprocity EE for the subsidiary’s investment in the parent company In the parent’s reciprocity EE, the subsidiary’s investment in the parent is ignored S’s investment in P is reclassified as treasury stock Noncontrolling interest in income is based on the reported income of S

EE’s in the consolidation worksheet in Year 02 Investment in S ,000 1/1 Retained earnings - P 45,000 To establish reciprocity for the investment by P in S Dividend income ,000 Dividends declared - P 3,000 Dividends declared - S 9,000 To eliminate intercompany dividends

EE’s in the consolidation worksheet in Year 02 Common stock - S ($200,000 x 90%) 180,000 1/1 Retained earnings - S ($100,000 x 90%) 90,000 Difference between cost and book value 15,000 Investment in S ,000 To eliminate P’s investment in S Treasury stock ,000 Investment in P ,000 To reclassify S’s investment in P as treasury stock

Treasury Stock Approach Equity Method
EE’s in the consolidation worksheet in Year 02 Investment in S 1,800 1/1 Retained earnings - P 1,800 To adjust for dividends of P paid to S from the date of acquisition to the beginning of the current year Equity in subsidiary income 51,300 Dividends declared - S ,000 Investment in S ,300 To eliminate intercompany income and dividends from S to P

EE’s in the consolidation worksheet in Year 02 Dividend income 3,000 Dividends declared - P 3,000 To eliminate intercompany income and dividends from P to S Common stock - S ($200,000 x 90%) 180,000 1/1 Retained earnings - S ($100,000 x 90%) 90,000 Difference between cost and book value 15,000 Investment in S ,000 To eliminate P’s investment in S

EE’s in the consolidation worksheet in Year 02 Treasury stock ,000 Investment in P ,000 To reclassify S’s investment in P as treasury stock

Chapter 10: Consolidated Financial Statements - Miscellaneous Topics

Intercompany Bold Holdings
Bonds acquired by an affiliate are no longer held by external parties In the consolidated financial statements: the bonds are viewed as being constructively retired record a gain or loss on this early retirement of debt

Allocation of Constructive Gain/Loss
Entirely to the issuing company Entirely to the purchasing company Entirely to the parent company Allocated between the purchasing and issuing companies Note: the allocation method affects the consolidated net income each year. However, it does not affect the total consolidated net income over the life of the issue.

Computation of Constructive Gain/Loss
Book value Constructive gain/loss allocated to issuing company Par value Constructive gain/loss allocated to purchasing company Purchase price

Accounting for Intercompany Bonds
An Example 12/31/2001 12/31/2003 P acquired S’s 9% bonds Bond matures Par value of bonds acquired = $500,000 x 60% Book value of bonds acquired = $480,000 x 60% Purchase price = $310,000

Book value $288,000 Constructive loss allocated to S Company $12,000 Par value $300,000 Constructive loss allocated to P Company $10,000 Purchase price $310,000

Year of Intercompany Bond Purchase - EE’s Loss on constructive retirement of bonds 10,000 Investment in S Bonds 10,000 (1) To recognize the constructive loss not recorded by P and (2) adjust the intercompany bonds to par value Loss on constructive retirement of bonds 12,000 Discount on bonds payable 12,000 (1) To recognize the constructive loss not recorded by S and (2) adjust the intercompany bonds to par value

Year of Intercompany Bond Purchase - EE’s Bonds payable 300,000 Investment in S Bonds ,000 To eliminate intercompany bond investment and liability

Intercompany Bonds Cost and Partial Equity Methods
Year After Intercompany Bond Purchase - EE’s Beginning retained earnings- P 10,000 Investment in S Bonds 10,000 (1) To record last year’s constructive loss not recorded by P and (2) adjust the intercompany bond investment to par value Beginning retained earnings- P 9,600 Beginning retained earnings- S 2,400 Discount on bonds payable 12,000 (1) To recognize the constructive loss not recorded by S and (2) adjust the intercompany bonds to par value

Year After Intercompany Bond Purchase - EE’s Investment in S Bonds 2,500 Interest revenue 2,500 To reverse amortization of premium recorded by P in the current year Discount on bonds payable 3,000 Interest expense 3,000 To reverse amortization of discount recorded by S in the current year

Year After Intercompany Bond Purchase - EE’s Interest revenue ,000 Interest expense ,000 To eliminate intercompany bond interest Bonds payable ,000 Investment in S Bonds ,000 To eliminate intercompany bond investment and liability

Intercompany Bonds Complete Equity Method
Year After Intercompany Bond Purchase - EE’s Investment in S ,600 Beginning retained earnings- S ,400 Discount on bonds payable 12,000 Investment in S Bonds 10,000 (1) To record last year’s constructive loss not recorded by P or S and (2) adjust the intercompany bond investment to par value

Year After Intercompany Bond Purchase - EE’s Investment in S Bonds 2,500 Interest revenue 2,500 To reverse amortization of premium recorded by P in the current year Discount on bonds payable 3,000 Interest expense 3,000 To reverse amortization of discount recorded by S in the current year

Year After Intercompany Bond Purchase - EE’s Bonds payable ,000 Investment in S Bonds ,000 To eliminate intercompany bond investment and liability Interest revenue ,000 Interest expense ,000 To eliminate intercompany bond interest

Intercompany Bonds Consolidated NI-Year after Bond Purchase
Reported income of P Dividend income Constructive loss recorded by P in the current year (premium amortization) P’s contribution to combined income Reported NI of S + Constructive loss recorded by S in the current year (discount amortization) Adjusted NI of S x P% Consolidated net income

Consolidated Retained Earnings Constructive loss NOT recorded by P Ending Reported R/E of P Increase in S R/E since acquisition x P% Increase in R/E of S - Constructive loss NOT recorded by S Consolidated R/E

Notes Receivable Discounted
Subsidiary Issues $100,000 note Parent Company Discount note with bank If S credits notes receivable upon discounting the note, no adjustment is needed in consolidation. If S credits notes receivable discounted upon discounting the note, an adjustment is needed in consolidation: Dr Notes receivable discounted Cr Notes receivable

Notes Receivable Discounted
Subsidiary Issues $100,000 note Parent Company Discount note with bank Receives note from third party If P and S credits notes receivable upon discounting the note, no adjustment is needed in consolidation. If P or S credits notes receivable discounted upon discounting the note, an adjustment is needed in consolidation: Dr Notes receivable discounted Cr Notes receivable

Stock Dividend from Subsidiary Journal Entries
Stock dividend declared (or R/E) 150,000 Capital stock ,000 Parent Memorandum entry only.

Stock Dividend from Subsidiary Eliminating Entries
Year of stock dividend Capital stock ,000 Stock dividend declared (or R/E) 150,000 To reverse the subsidiary’s JE on stock dividend

Subsidiary with Preferred Stock
Book value of net assets Less: allocated to preferred stock par value + call premium + dividends in arrears = residual allocated to common stock

Noncontrolling interest Preferred stock held by parent Common stock held by parent Preferred stock not held by parent Common stock not held by parent Controlling interest

Controlling Interest in Net Income Reported income of P Dividend income Other adjustments P’s contribution to combined income P’s share of S adjusted income Consolidated net income Adjusted NI of S assigned to preferred stock x (P’s prefered stock %) + Adjusted NI of S assigned to common stock x (P’s common stock %)

Chapter 11: Alternative Concepts of Consolidated Financial Statements

Pooling of Interests Method
Recent developments Upsurge in pooling activity in 1998 FASB voted to eliminate the pooling method in 4/1999 exposure draft eliminating the pooling method issued in 9/1999 final standard expected late 2000

Pooling of Interests Method
Why is the FASB considering elimination of the pooling method? The purchase method provides better information on the profitability of an investment International compatibility

Pooling of Interests Method Stock Acquisition
Main Requirement a stock acquisition through an exchange of voting stock for at least 90% of the voting stock of the acquired company

Wholly Owned Subsidiary Equity Allocation
Case A: P issued shares with par value of $60,000 Other Contributed Capital - S $10,000 Retained Earnings - S $20,000 Common stock -S $50,000 $10,000 $50,000 $20,000 Common Stock - P $200,000 Other Contributed Capital - P $40,000 Retained Earnings - P $100,000

Wholly Owned Subsidiary Journal Entry
Case A: P issued shares with par value of $60,000 net assets acquired are recorded at their book value Investment in S 80,000 Common Stock ,000 Retained Earnings 20,000 Total shareholders’ equity of S Company ($80,000) is carried forward to P Company Par value of common stock issued is recorded

Wholly Owned Subsidiary Eliminating Entry
Case A: P issued shares with par value of $60,000 Common stock - S 50,000 Other contributed capital - S 10,000 Retained earnings - S 20,000 Investment in S 80,000 There is no purchase differential under pooling method because the investment account carries the book value of S

Case B: P issued shares with par value of $90,000 Other Contributed Capital - S $10,000 Retained Earnings - S $20,000 Common stock -S $50,000 $10,000 $50,000 $20,000 Common Stock - P $200,000 Other Contributed Capital - P $40,000 Retained Earnings - P $100,000 $30,000

Case B: P issued shares with par value of $90,000 net assets acquired are recorded at their book value Investment in S 80,000 Other contributed capital 30,000 Common Stock ,000 Retained Earnings 20,000 Total shareholders’ equity of S Company ($80,000) is carried forward to P Company Par value of common stock issued is recorded

Case C: P issued shares with par value of $110,000 Other Contributed Capital - S $10,000 Retained Earnings - S $20,000 Common stock -S $50,000 $10,000 $10,000 $50,000 $10,000 Common Stock - P $200,000 Other Contributed Capital - P $40,000 Retained Earnings - P $100,000 $40,000

Case C: P issued shares with par value of $110,000 net assets acquired are recorded at their book value Investment in S 80,000 Other contributed capital 40,000 Common Stock ,000 Retained Earnings ,000 Total shareholders’ equity of S Company ($80,000) is carried forward to P Company Par value of common stock issued is recorded

95% Owned Subsidiary Equity Allocation
Case D: P issued shares with par value of $50,000 Other Contributed Capital - S $9,500 Retained Earnings - S $19,000 Common stock -S $47,500 $2,500 $47,500 $7,500 $19,000 Common Stock - P $200,000 Other Contributed Capital - P $40,000 Retained Earnings - P $100,000

95% Owned Subsidiary Journal Entry
Case D: P issued shares with par value of $50,000 net assets acquired are recorded at their book value Investment in S 76,000 Common Stock ,000 Other contributed capital 7,000 Retained Earnings 19,000 Total shareholders’ equity of S Company ($80,000) is carried forward to P Company Par value of common stock issued is recorded

95% Owned Subsidiary Eliminating Entry
Case D: P issued shares with par value of $50,000 Common stock - S 47,500 Other contributed capital - S 9,000 Retained earnings - S 19,000 Investment in S 76,000 There is no purchase differential under pooling method because the investment account carries the book value of S

Accounting for a Pooled Subsidiary After Acquisition
Book value method equivalent to cost method in a purchase Partial equity method Complete equity method

Accounting After Acquisition Book Value Method
Journal entries of parent: investment account remains unchanged unless the parent buys or sells shares of the subsidiary parent records dividend income from subsidiary

Accounting After Acquisition Book Value Method
Eliminating entries: reciprocity EE dividend EE investment EE The eliminating entries are similar to those under purchase method, without allocation and amortization of purchase differential

Accounting After Acquisition Partial or Complete Equity Method
Journal entries of parent: investment account is increased for the parent’s share of reported net income of subsidiary investment account is decreased for dividends received from the subsidiary complete equity method: investment account is adjusted for unrealized profit from intercompany sale of inventory or equipment

Accounting After Acquisition Partial or Complete Equity Method
Eliminating entries: dividend EE investment EE The eliminating entries are similar to those under purchase method, without allocation and amortization of purchase differential

Interim Acquisition Revenues and expenses of the subsidiary are included in the consolidated income statement for the entire year The investment account is recorded as if the pooling took place at the beginning of the year No “net income purchased”

Intercompany Sale of Assets
All unrealized profit from intercompany sale of inventory or property is excluded from consolidated financial statements The eliminating entries are similar to those under purchase method

Alternative Concepts of Consolidation
Parent Company Concept Economic Unit Concept Current practice is a compromise between the two general concepts

Parent Company Concept
Focus: the interests of the parent’s shareholders consolidated balance sheet = parent’s balance sheet + assets and liabilities of subsidiary substituted for the Investment in S account consolidated income statement = parent’s income statement + revenues, expenses, gains and losses of subsidiary substituted for the parent’s income from investment

Economic Unit Concept Focus: control of the whole by a single management the parent and the subsidiary as a single economic unit consolidated balance sheet = assets and liabilities of all affiliated companies consolidated income statement = revenues, expenses, gains and losses of all affiliated companies

Chapter 12: International Accounting and the Global Economy

Increasing Interest in International Accounting Standards
Cross border equity issuances Call for: uniform international accounting standards Internationalization of portfolio holdings Shift toward equity financing

Divergence in Accounting Standards
In some countries: Goodwill is not amortized until it is apparent it has diminished in value The pooling of interests method is not allowed LIFO inventory costing is not permitted Reserves are recorded for self-insurance or contingencies for expected future losses

International Accounting Standards Committee (IASC)
An independent private-sector body established in 1973 by the leading accountancy bodies of Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the United Kingdom and Ireland, and the United States Issues International Accounting Standards (IAS)

Earnings Differences among Countries An Illustration
Most conservative Japan Germany France United States Least conservative United Kingdom

Accounting Models

International Accounting Issues Consolidation Methods
U.S GAAP purchase and pooling allowed IAS purchase is required uniting of interests (similar to pooling) is allowed if firm sizes are similar Other Countries pooling is not permitted in Japan and used infrequently in other countries

International Accounting Issues Property, Plant and Equipment
U.S GAAP recorded at historical cost carried on books at net book value IAS initial measurement is original cost revaluation to fair value is allowed Other Countries In France and U.K., common to revalue assets to an equity reserve account

International Accounting Issues Depreciation
U.S GAAP predominantly straight line method for financial purposes alternative methods for tax purposes IAS method applied on a systematic basis Other Countries In Japan and Latin America, taxation authorities determine depreciation methods

International Accounting Issues Research and Development
U.S GAAP all R&D costs are expensed IAS research costs are expensed development costs may be recognized as an intangible asset Other Countries In Japan, some R&D costs can be capitalized and amortized for up to 5 years In the UK, some development costs are capitalized

International Accounting Issues Goodwill
U.S GAAP capitalized and amortized for up to 40 years IAS capitalized and amortized for up to 5 years, (up to 20 years if justified) Other Countries capitalized and amortized over a shorter time period in most countries immediately written off in Germany

International Accounting Issues Inventories
U.S GAAP LIFO and FIFO are primary methods IAS lower of cost or net realizable value is recommended FIFO and weighted average are primary methods LIFO allowed Other Countries LIFO is not acceptable for tax purposes in the U.K. and Canada, hence limited use

International Accounting Issues Deferred Taxes
U.S GAAP liabilities and assets recorded on all taxable and deductible temporary differences valuation allowances used if asset is not probable IAS liabilities and assets recorded if probable no deferred taxes on nontaxable goodwill Other Countries In the U.K. and Germany, the liability method is used In Japan, deferred taxes are not recognized

U.S. Listings for Non U.S. Companies
Required registration with the SEC to be listed only: form 20-F to issue securities in the U.S.: F-1 statement subsequent periods: form 20-F (annual reports) and form 6-K (interim reports)

+ 20-F Statement the non-U.S. company’s local GAAP reporting
reconciliation of net income and shareholders’ equity to comply with U.S. GAAP; or full disclosure of financial information required of U.S. firms, including segmental disclosures

F-1 Statement Required for first time offer of securities by a non-U.S. company (foreign private issuer) The company must meet certain conditions of: ownership, location of assets, and location of executive officers Must contain the prospectus containing financial statements (reconciled to U.S. GAAP) detailed nonfinancial information

F-1 Statement - Content The prospectus containing
financial statements (reconciled to U.S. GAAP) description of business regulatory structure management structure capital structure shareholding patterns shareholder rights Information about articles of association, bylaws, significant legal and contractual obligations of the company

American Depository Receipts (ADRs)
Definition a derivative financial instrument usually representing a certain fixed number of publicly traded shares of a non-U.S. corporation Trading ADRs may trade freely, subject to some conditions, like any U.S. security on the major exchanges

American Depository Receipts (ADRs)
Depository Bank (DR Bank) an intermediary creating ADRs, usually with the consent of the issuing company provides an interface between the non-U.S. company and U.S. investors major DR banks: Bank of New York, J.P.Morgan, Citibank

Process of Creating ADRs
DR bank purchases shares of non-U.S. company from its home market DR bank places shares with its custodian in the home market DR bank issues ADRs (denominated in U.S. $)

Types of ADR Programs Unsponsored ADRs
The DR bank creates a DR program without a formal agreement with the issuing non-U.S. company usually arise due to great demand for the company’s securities in the U. S. becoming obsolete

Types of ADR Programs Sponsored ADRs
The DR bank creates a DR program with an exclusive agreement with the issuing non-U.S. company The DR bank provides information and disburse payouts (dividends, rights, etc) to U.S. investors account for over 98% of ADRs

Types of Sponsored ADRs

Chapter 13: Accounting for Foreign Currency Transactions

Indirect exchange rate
Exchange Rates Direct exchange rate how many units of the domestic currency can be converted into one unit of foreign currency e.g., 1.517: $ British pound Indirect exchange rate how many units of the foreign currency can be converted into one unit of domestic currency e.g., .6592: $ British pound

Exchange Rates Spot rate Forward or future rate
exchange rate for immediate delivery of currencies exchanged Forward or future rate exchange rate for future delivery of currencies exchanged

Official or fixed rates
Exchange Rates Official or fixed rates the country maintains the actual exchange rate of its currency within 2% of the official rate by buying or selling U.S. dollars or gold Floating rates the currency’s exchange rate is determined by supply and demand factors increases risk to companies doing business with a foreign company

Measured VS Denominated
transactions are normally measured and recorded in the currency in which the reporting entity prepares its financial statements Assets and liabilities are denominated in a currency if their amounts are fixed in terms of that currency

Foreign Currency Transactions
Definition A transaction that requires settlement in a foreign currency Examples: importing or exporting goods on credit borrowing or lending to a foreign company hedging a net investment in a foreign entity forward contract

Importing or Exporting Goods or Services
Transaction date Balance sheet date Settlement date Record transaction as: units of foreign currency x current exchange rate Settle accounts denominated in foreign currency as: units of foreign currency x current exchange rate Record accounts denominated in foreign currency as: units of foreign currency x current exchange rate

Transaction date Balance sheet date Settlement date Foreign currency transaction gain/loss = units of foreign currency x change in exchange rate Foreign currency transaction gain/loss = units of foreign currency x change in exchange rate Treatment of foreign currency transaction gain/loss Net income Net income

Foreign currency transaction gain/loss is included in net income except long-term financing or capital transactions with an investee consolidated or accounted for by the equity method (included in S/E) economic hedges of a net foreign investment (included in S/E) economic hedges of an identifiable foreign currency commitment (deferred)

Importing Transactions An Example
Inventory delivered 12/1/2001 French firm U.S. firm 500,000 euros to be paid on 3/1/2002 Spot rates: Transaction date: $1.05 Balance sheet date: $1.08 Settlement date: $1.07

12/1 (Transaction date) Purchases ,000 Accounts payable ,000 500,000 euros x $1.05/euro 12/31 (Balance sheet date) Transaction loss 15,000 Accounts payable ,000 500,000 euros x $( )/euro

3/1 (Settlement date) Accounts payable ,000 Transaction gain ,000 Cash ,000 Gain = 500,000 euros x $( )/euro

Exporting Transactions An Example
Inventory delivered 12/1/2001 French firm U.S. firm 500,000 euros to be received on 3/1/2002 Spot rates: Transaction date: $1.05 Balance sheet date: $1.08 Settlement date: $1.07

12/1 (Transaction date) Accounts receivable 525,000 Sales ,000 500,000 euros x $1.05/euro 12/31 (Balance sheet date) Accounts receivable 15,000 Transaction gain 15,000 500,000 euros x $( )/euro

3/1 (Settlement date) Cash ,000 Transaction loss ,000 Accounts receivable ,000 Gain = 500,000 euros x $( )/euro

Economic Hedge of Foreign Investment
Conditions the forward contract is designated as, and is effective as, a hedge of the net investment; and the foreign currency commitment is firm

Forward Exchange Contracts
Definition An agreement to exchange currencies of two different countries at a specified rate (the forward rate) on a stipulated future date

Uses of Forward Exchange Contracts
Hedges to hedge a foreign currency exposed receivable or payable to hedge a net investment in a foreign entity to hedge an identifiable foreign currency commitment Speculation to speculate in foreign currency in anticipation of a gain

Hedge: Foreign Currency Exposed Liability
Inventory delivered 12/1/2001 French firm U.S. firm 500,000 euros to be paid on 3/1/2002 Forward contract $ to be received on 3/1/2002 Exchange dealer U.S. firm 500,000 euros to be received on 3/1/2002 Spot rates: Transaction date: $1.05 Balance sheet date: $1.08 Settlement date: $1.07

12/1 (Transaction date) Purchases ,000 Accounts payable ,000 500,000 euros x $1.05 spot rate Foreign currency (FC) receivable 525,000 Premium on forward contract 2,500 Dollars payable ,500 500,000 euros x $1.055 forward rate

12/31 (Balance sheet date) Transaction loss 15,000 Accounts payable 15,000 The transaction gain and loss offset each other 500,000 euros x $( ) change in spot rate Foreign currency (FC) receivable 15,000 Transaction gain 15,000 Amortization expense ($2,500/3) 833 Premium of forward contract 833 Amortization of premium of FC

3/1 (settlement date) Accounts payable 5,000 Transaction gain 5,000 Transaction loss 5,000 Foreign currency (FC) receivable 5,000 500,000 euros x $( ) change in spot rate Dollars payable ,500 Investment in FC ,000 FC receivable ,000 Cash ,500 To record settlement of FC contract

3/1 (settlement date) Accounts payable ,000 Investment in FC ,000 To record settlement of account payable Amortization expense ($2,500/3) 833 Premium of forward contract 833 Amortization of premium of FC

Hedge of a Forecasted Transaction
Balance sheet date Settlement date 12/1/2001 U.S. firm estimates sales to the U.K. in 1/2002 for 500,000 euros Spot rates: 12/1/2001: $1.03 12/31/2001: $1.00 2/1/2002: $0.98 U.S. firm purchased an option for $5,000, allowing the firm to sell 500,000 euros at $1.02

12/1 (Transaction date) Options to sell euros 5,000 Cash ,000 To record purchase of options 12/31 (Balance sheet date) Options to sell euros 9,000 Deferred gain on option 9,000 The deferred gain is reported in other comprehensive income, not as part of net income

2/1 (Option expiration date) Options to sell euros 6,000 Gain on options 6,000 To adjust option to its realizable value of $20,000 Deferred gain on option 9,000 Options to sell euros 9,000 To transfer the deferred gain from equity to net income

2/1 (Option expiration date) Cash ,000 Options to sell euros ,000 Payable to option trader ,000 Exercise the option and settle with the trader

Foreign Currency Commitment
A U.S. firm may commit to a foreign firm to sell or buy goods, and the price is established in foreign currency change in exchange rate between the commitment date and transaction date is reflected in the cost or sale price, not a separate gain or loss The U.S. firm may enter a forward contract to hedge its commitment

Hedge of an Identifiable Foreign Currency Commitment
Conditions: the forward contract is designated as, and is effective as, a hedge of the foreign currency commitment the foreign currency commitment is firm

Hedge of an Identifiable Foreign Currency Commitment
Effective hedging gain/loss on the forward contract deferred and included in the measurement of the related foreign currency transaction when recorded i.e., treat the forward contract as an integral part of the importing or exporting transaction Non-hedging gain/loss on the forward contract not deferred included in net income in the current period

Forward Contracts for Speculation
The forward contract is carried at forward rate at balance sheet date over remaining life of the contract Transaction gain/loss reported in net income of current year

Chapter 14: Translation of Financial Statements of Foreign Affiliates

Foreign Subsidiaries A foreign subsidiary is consolidated if the parent company owns a controlling interest in the subsidiary Exceptions: The intent to control is temporary Control does not rest with the parent government restrictions on asset withdrawal exchange restrictions

Translating Financial Statements of Foreign Affiliates
Translation: the conversion of financial statements from one currency to another Financial statements in U.S. dollars Financial statements in Franc Translation

Exchange Rates Current exchange rate = the spot rate on the balance sheet date Historical exchange rate = the spot rate on the transaction date

Functional Currency Definition: can be:
Functional currency of a foreign affiliate is the currency of the economic environment in which it primarily conducts its operations can be: local currency of the affiliate the U. S. dollar a third currency

Translation Methods Current Rate Method
all assets and liabilities are translated using the current exchange rate revenues and expenses - average exchange rate Temporal Method monetary assets and liabilities - current exchange rate assets and liabilities carried at historical cost - historical exchange rate assets and liabilities carried at current value - current exchange rate

Functional Currency Indicators
cash flows sales prices sales market expenses financing intercompany transactions

Determining Functional Currency
Accounts stated in local currency of foreign affiliate Do economic indicators show that functional currency = U.S. $? No Foreign economy highly inflationary? No Yes Yes Function currency = local currency Function currency = U.S. $ Function currency = U.S. $ Remeasurement Remeasurement Translation

Remeasurement VS Translation
convert financial statement elements using temporal method translation adjustment included in net income Translation convert financial statement elements using current rate method translation adjustment recorded in stockholders equity

Translation Process Books kept in local currency Local currency
Remeasure- ment Not necessary Temporal method Temporal method A third currency Local currency U.S. dollar Functional currency Not necessary Translation Current rate method Current rate method Financial statements in U. S. dollars U.S. dollar

Translation (Current Rate Method)
Assets and liabilities Paid-in capital: purchase acquisition pooling Current exchange rate Historical rate on the date of acquisition Historical rate on the date of capital transaction of subsidiary

Beginning R/E Dividends Revenue and expenses Cumulative translation adjustment = Ending balance of last year Historical rate when dividend is declared Average exchange rate = Balance amount in the balance sheet

= Balance amount in the balance sheet “Other comprehensive income” in shareholders equity Cumulative translation adjustment Current year

Remeasurement (Temporal Method)
Monetary assets and liabilities carried at current values Nonmonetary assets and liabilities carried at current values at historical costs Current exchange rate Historical rate on the date of transaction

Paid-in capital: purchase acquisition pooling Historical rate on the date of acquisition Historical rate on the date of capital transaction of subsidiary

Beginning R/E Dividends = Ending balance of last year Historical rate when dividend is declared

Revenues and expenses related to assets and liabilities translated at historical rates (inventory cost and depreciation) Other revenues and expenses Historical rate used for the related asset or liability accounts Average exchange rate

Net income Current year translation adjustment

Financial Statement Disclosure
Aggregate translation gain/loss included in net income disclosed in (notes to) financial statement Exchange rate changes that occur after the balance sheet date and their effect on unsettled foreign currency transactions, if significant

Analysis of the cumulative translation adjustment should be presented as part of statement of changes in equity or in a separate statement

Analysis of the cumulative translation adjustment includes beginning and ending amounts current period’s aggregate adjustment translation of foreign currency statements gains/losses from hedging activities and intercompany long-term investment transactions income taxes allocated amount transferred to net income

Chapter 15: Reporting for Segments and for Interim Financial Periods

Need for Disaggregated Financial Data
Different industries or geographic areas may have different rates of profitability growth opportunities types of risks Difficult to analyze a firm engaging in several industries or geographic areas based on aggregated information

Segmental Disclosures
Advantage unveiling of information that has been merged in the consolidated data Disadvantages may be misleading due to classification and allocation problems, lack of user knowledge, etc. disclosure to competing firms and labor unions information overload for users

Common Cost Allocation - Which?
Common costs should be allocated to a segment for external reporting purposes only if they are included in the segment’s internal profit or loss calculations

Common Cost Allocation - How?
Steps Joint costs are accumulated into logical and relatively homogeneous expense pools The pools are allocated to segments on the basis of beneficial or casual relationships as measured by activity or output of the segments

Common Cost Allocation - How?
Joint costs Centralized warehouse expenses Data processing expenses Expense pools Segments

Operating Segment Definition:
It is a component of the firm that engages in business activities that earns revenues and incur expenses The entity’s chief operating decision maker regularly reviews the component’s operating results Discrete financial information is available

Determining Operating Segments
Modified management approach focus on the way in which management organizes segments internally to make operating decisions and to assess performance aggregation criteria quantitative thresholds

Aggregation Criteria An entity is permitted to aggregate operating segments which are similar in all the following areas: nature of their products or services nature of the production process types or classes of customers methods used to distribute products or provide services nature of regulatory environment

Quantitative Thresholds
A segment is significant enough to be a reportable segment if : its combined external and internal revenue > 10% of the combined external and internal revenue of all reportable segments; its reported profit or loss > 10% of the total gross profit (loss) of all operating segments reporting a profit (loss); or its assets > 10% of combined assets of all operating segments

75% Combined Revenue Test
Combined sales to unaffiliated customers of all reportable segments Must be > 75% Combined sales to unaffiliated customers of all operating segments If the 75% test is not met, additional segments must be identified

Segmental Disclosure Requirements
general information segment operating profit or loss segment assets bases for measurement reconciliation of segment amounts and consolidated amounts for revenue profit or loss assets other significant items

Segmental Disclosure Requirements
interim disclosures enterprisewide disclosures product or service geographic area major customers - each customer representing 10% or more of total enterprise revenues methods of presentation financial statements footnotes to the financial statements separate schedule

operations in foreign countries should be grouped on the basis of
Geographic Area operations in foreign countries should be grouped on the basis of proximity economic affinity similarities of business environments nature, scale, and degree of interrelationship of the operations in the various countries

Major Customers Purpose: To provide information about dependency on one or more major customers Disclosure requirement each customer representing 10% or more of total enterprise revenues customers who are federal, state, local, or foreign government amount of sales segment making the sales

Interim Financial Reporting
Purpose: to provide timely financial information for investment decision making SEC disclosure requirement: Form 10-Q comparative income statements for the quarter and year-to-date for the current and preceding year comparative statements of financial position at the end of the most recent quarter for the current and preceding year

Interim Reporting - Inventory Costing
COGS can be estimated using gross profit rate Liquidated LIFO base should be charged at replacement cost if expected to be replaced by year end Inventory loss from market declines expected to recover before year end need not be recognized Price and volume variances under standard costing should be deferred if expected to be absorbed by year end

Interim Reporting - Income Taxes
Steps (1) estimate effective tax rate for the full year income of year-to-date year-to-date tax provision estimated tax rate tax provision up to preceding quarter year-to-date tax provision current quarter’s tax provision = (2) x _ = (3)

First Quarter JE Income tax expense 42,300 Income tax payable ,300 To record income tax provision for the first quarter as: (actual first quarter income) x (estimated tax rate for the year) = $15,000 x 28.2%

Second Quarter JE Income tax expense 48,900 Income tax payable ,900 Second quarter First quarter Year to date tax provision = $42,300 Year to date tax provision = $91,200 Difference = $48,900

Interim Reporting - Accounting Changes
Changes in estimate accounted for in the interim period when the change is made no restatement of previous interim reports effect on earnings disclosed for current and subsequent interim periods

Interim Reporting - Accounting Changes
Changes in principle if the change occurs in the first quarter: the cumulative effect should be included in the first quarter income. if the change occurs in other than the first quarter: the cumulative effect should be shown as if it had occurred in the first quarter. All other quarters should be restated using the new method.

Interim Reporting - Minimum Disclosure
Gross revenues, income tax provisions, extraordinary items, cumulative effect of a change in accounting principles, net income basic and diluted EPS seasonal revenue, or expenses segment disposal; extraordinary, unusual or infrequent items contingent items changes in accounting principles or estimates significant changes in financial position

Chapter 16: Partnerships: Formation, Operation, and Ownership Changes

Partnership Definition Attributes
An association of two or more persons to carry on as co-owners of a business for profit Attributes an agreement the business operates for profit members of the firm must be co-owners

General Partnership All partners are general partners Mutual agency
Right to dispose of a partnership interest Unlimited liability Limited or uncertain life Tax implications: partnership income is allocated to partners who are taxed upon

Limited Partnership At least one general partner and one limited partner General partner: manage the firm unlimited liability Limited partner: invest capital only limited liability

Joint Venture An agreement by two or more parties to accomplish a limited purpose for their mutual benefit, often to earn a profit. Each joint venturer participates directly or indirectly in the management of the resources

Partnership Agreement
name of the firm, identity of the partners nature, purpose and scope of business date of organization length of operating time location of business allocation of profit and loss salaries and withdrawals of assets by partners rights, duties and obligations of each partner contractual authority of each partner

Partnership Agreement
procedure for admitting a new partner plan on withdrawal or death of a partner procedures for arbitration of disputes fiscal period identification and valuation of initial asset investments situations for dissolution of partnership accounting practices whether an audit is to be performed

Capital Interest VS Profit Interest
a partner’s claim against the net assets of the partnership shown by the balance in the partner’s capital account Profit interest a partner’s claim against income and loss of the partnership determines how the partner’s capital interest changes as a result of partnership operations

Accounting for a Partnership
Formation of Partnership Cash ,000 Bell, capital ,000 Peters, capital ,000 Monthly Withdrawal Bell, drawing 1,000 Peters, drawing 1,000 Cash ,000

Accounting for a Partnership
Income Summary Closing Entry Income summary 60,000 Bell, capital ,000 Peters, capital ,000 Drawing Accounts Closing Entry Bell, capital ,000 Peters, capital 12,000 Bell, drawing ,000 Peters, drawing ,000

Fair value of assets invested
Bonus Method MV of asset investment = negotiated capital interest Assets contributed by Wright $40,000 Wright, capital $45,000 Fair value of assets invested $90,000 Assets contributed by Young $50,000 Young, capital $45,000

Goodwill Method MV of asset investment = negotiated capital interest
Goodwill of $10,000 is recorded Wright, capital $50,000 Assets contributed by Wright $40,000 $90,000 Fair value of assets invested Assets contributed by Young $50,000 Young, capital $50,000

Profit/Loss Allocation
Fixed Ratio Profit $20,000 7:3 Adams $14,000 Brown $6,000

Capital Balances 7:3 Adams Capital $60,000 Brown Capital $40,000 = 3:2 Profit $20,000 3:2 Adams $14,000 Brown $6,000

Interest Allocation Steps: (1) Allocate profit as interest on capital investment (2) allocate the remaining income on another basis

Interest Allocation The following should be specified: the interest rate capital balance to be used how remaining profit should be allocated whether or not interest should be allocated if profit < agreed interest allocation

Interest Allocation Profit $20,000 Interest allocation Unallocated profit Adams $6,200 7:3 Brown $3,000 Allocation of remaining profit Interest allocated = capital balance x interest rate Adams $5,400 Brown $5,400 1:1

Salary and Bonus Allocation Allocate profit as: fixed salary or provide for a bonus as a % of net income The net income used in bonus calculation can be before allocation of income to partners after other allocations, but before the bonus after bonus, but before other allocations after bonus and all other allocations

Insufficient Income to Cover Allocation
If partnership income > interest and/or salary allocation allocate the deficiency in the agreed ratio for allocating residual income

Insufficient Income to Cover Allocation
Profit $11,000 Salary allocation Interest allocation Deficiency in profit Adams $4,000 Brown $2,000 7:3 Adams $6,200 Brown $3,000 Adams ($2,100) Brown ($2,100) 1:1

Financial Statement Presentation
Difference between partnership and corporation reporting: changes in partners’ equity during the year should be disclosed partners’ salary allowances is not an expense no income tax expense interest on capital investment is not an expense.

Admission of New Partner
A new partner can acquire an interest in a partnership by: purchasing an interest from an existing partner New partner acquires the right to share profits only no right to participate in management unless granted by all remaining partners investing assets

Assignment of Partnership Interest
By Payment to Partners - Bonus Method Adams, Capital ,000 Brown, Capital 12,000 Call, Capital ,000 To transfer capital from capital accounts of Adams and Brown to Call’s capital account. Amounts = recorded capital x % interest acquired by Call

Assignment of Partnership Interest
By Payment to Partners - Goodwill Method Goodwill ,000 Adams, Capital ,000 Brown, Capital ,000 To record implied goodwill = Call’s payments / % interest acquired - recorded partnership net assets = $36000 / 30% -$100,000 Adams, Capital ,000 Brown, Capital 12,000 Call, Capital ,000 To transfer capital from capital accounts of Adams and Brown to Call’s capital account.

Asset Investment BV Acquired = Assets Invested
Cash ,000 Call, Capital ,000 To record Call’s 1/3 capital in the partnership = (existing net assets + assets invested by Call) x 1/3 = ($70,000 + $35,000) x 1/3 = $35,000

Asset Investment BV Acquired < Assets Invested : Bonus Method
Cash ,000 Call, Adams ,000 Call, Brown ,000 Call, Capital ,000 The excess is considered a bonus to the existing partners To record Call’s 1/3 capital in the partnership = (existing net assets + assets invested by Call) x 1/3 = ($70,000 + $50,000) x 1/3

Asset Investment BV Acquired < Assets Invested : Goodwill Method
Adams, Capital ,000 Brown, Capital ,000 Implied total net assets = Call’s payments / % interest acquired = $50000 / 30% = $150,000 goodwill for existing partners = implied net assets x % ownership - current capital accounts = $150,000 x 2/3 - $70,000 = $30,000

Asset Investment BV Acquired < Assets Invested : Goodwill Method
Cash ,000 Call, Capital ,000 To record Call’s 1/3 capital in the partnership = (implied net assets) x 1/3 = $150,000x 1/3

Payment to a Retiring Partner
Payment > BV: Bonus Method Call, Adams ,000 Call, Brown ,000 Call, Capital ,000 Liability to Adams ,000 The excess is considered a bonus to the retiring partners; allocated to existing partners by their profit and loss ratio To record $40,000 agreed payment to Adams

Payment to a Retiring Partner
Payment > BV: Goodwill Method Goodwill ,000 Adams, Capital ,000 Brown, Capital ,000 Call, Capital ,000 Implied goodwill = excess payment to Adams / % interest withdrawn = $10000 / 50% = $200,000 The goodwill is allocated to partners by their profit and loss ratio

Chapter 17: Partnership Liquidation

Steps in Liquidation Process
Compute net income or loss up to the date of dissolution, allocate to partners Convert assets into cash if necessary, record gain or loss and allocate to partners Distribute assets to creditors and partners

Order of Payment creditors other than partners loans from partners
capitals of partners profits of partners

Joint and Several Liability
legal action may be brought against all partners together or against any one or more of the partners in separate suits

Marshaling of Assets recognition of the rights of partnership and personal creditors and the classification of assets into partnership and personal categories

Right of Offset A partner with an outstanding loan to the partnership can offset the loan against his debit capital balance

Priorities of Claims against Partnership Assets
partnership creditors personal creditors that did not recover their claims in full from personal assets limited to the partner’s capital interest in the partnership

Priorities of Claims against Personal Assets
personal creditors partnership creditors that did not recover their claims in full from partnership assets regardless of the partner’s capital interest in the partnership claims of partnership against the partner i.e., a deficit equity interest

Simple Liquidation Sequence of events
sale of all noncash assets and allocation of loss based on their profit and loss ratio payment to creditors offset loan against debit capital balance allocate debit capital balance of insolvent partner investment by partners payment to partners based on their capital balances

Installment Liquidation
noncash assets are sold over an extended period partners receive cash in installments problems: distribution of cash to partners before total liquidation loss is known potential wrongful distributions against the interest of creditors or individual partners

Safe Payment Approach Assumptions:
a loan to or from a partner will be combined with the partner’s capital account remaining noncash assets will not provide additional cash a partner with a deficit capital account will be unable to make additional investment

Safe Payment Approach Procedure
a safe payment schedule is prepared each time cash is to be distributed

Advance Cash Distribution Plan
A schedule that specifies the order in which each partner will participate in cash distribution the amount of cash each partner will receive as it becomes available for distribution

Advance Cash Distribution Plan - Steps
net capital interest of each partner = capital account +/- loans to (from) partnership order of participation = ranking by: loss absorption potential (= net capital interest / profit and loss ratio) amount of cash distributed to each partner = (difference in loss absorption potentials of partner and next ranking partner) x (profit and loss ratio)

Incorporation of a Partnership
Advantages of incorporation limited liability continuity of existence ability to raise resources

Procedures assets and liabilities are transferred to the corporation partners receive capital stock in settlement of their interests partnership accounts restated to fair values

Accounting Steps The partnership books may be retained for use by the corporation or a new set of books may be established

Retention of Partnership Books
Valuation JE Inventory 2,000 Land ,000 Equipment ,000 Accounts receivable Valuation adjustment 5,600 To adjust assets and liabilities to fair value. The gains and losses are accumulated in the valuation adjustment account.

Valuation-Closing JE Valuation adjustment 5,600 Art, capital ,800 Beck, capital ,800 To close the valuation adjustment account to the partners’ capital accounts by their profit and loss ratio.

Capital-Closing JE Art, capital ,800 Beck, capital ,800 Capital stock ,600 To close the capital account upon transfer of capital stock

New Books Established All accounts in partnership books will be closed
the corporation records the assets received and liabilities assumed at fair value

Advanced Accounting First Edition by Debra Jeter and Paul Chaney
Chapter 18: Introduction to Fund Accounting

Fund Accounting for nonbusiness organizations governmental units
hospitals colleges and universities voluntary health and welfare organizations Others trade associations, professional associations, museums, etc.

Fund Accounting - the Basics
Separates assets, liabilities and residual equity (fund balance) into distinct funds each fund is created for a specific activity or objective each fund consists of a self-balancing set of accounts each fund constitutes a separate accounting entity

Statement of financial positions:
Expendable Funds Purpose: To record inflows and outflows of financial resources to be expended for a specific use Statement of financial positions: Financial resources cash, and claims to cash (e.g. receivables, investments in marketable securities) Claims against the financial resources Fund balance _

Statement of operations :
Expendable Funds Statement of operations : Financial resources inflows (by source) Financial resources outflows (by function) Change in fund balance _

Statement of financial positions:
Proprietary Funds Purpose: To account for activities that are similar to business enterprises Statement of financial positions: Assets (current and non-current) Liabilities (current and non-current) Equity (net assets) _

Proprietary Funds Statement of revenues, expenses, and changes in fund net assets: Operating revenues Less: operating expenses Operating income Plus: non-operating revenues and expenses Income before other revenues, expenses, … Other revenues, exp, etc.: capital contributions, … Increase (decrease) in net assets Plus: net assets (beginning) Net assets (ending)

Budgetary (Governmental) Funds
Purpose: To formally incorporate the budget into the accounting records Appropriations budgeted expenditures the maximum expenditures authorized by the legislature

Types of Expendable Funds
Restricted funds financial resources restricted by donors or other outside agencies for specific operating purposes Unrestricted funds financial resources available to carry out the general activities of the organization at the discretion of the governing board

Accounting for Expendable Funds
Modified accrual basis of accounting revenues = increase in net financial resources other than increases from other financing sources expenditures = decrease in net financial resources other than decreases from other financing uses Other financing sources and uses (and transfers) = proceeds from debt issuances and transfers of financial resources to/from other funds

Critical Events in the Use of Financial Resources
Appropriation / Authorization e.g., purchase order Encumbrances e.g., receipt of goods Expenditure Disbursement e.g., payment

General Fund - the Budget
The budget is recorded at the beginning of the fiscal period Budgeted Income Estimated revenue 1,860,000 Unreserved fund balance ,000 Appropriations 1,944,000 To record budgeted revenue and expenditures at the beginning of the period

General Fund - the Budget
Budgeted Transfer-From Due from enterprise fund ,000 Transfers from other funds ,000 To record budgeted transfer of resources from other funds Budgeted Transfer-To Transfers to other funds ,000 Due to enterprise fund ,000 To record budgeted transfer of resources to other funds

General Fund - Revenues
Revenues are recorded against an increase in assets (I.e. receivables, cash, etc.) Property Tax Levied Property tax receivable 1,287,500 Estimated uncollectible taxes ,750 Revenue ,157,750 To record property taxes at the time they are levied

Services Rendered Other receivables 80,000 Revenue ,000 To record billings for routine services Collection of Fees Cash ,000 Revenues ,000 To record collection of licenses, permits, fees, etc.

Sale of Capital Assets Cash ,250 Revenues ,250 To record proceeds from sale of used furniture and equipment. Note: proceeds from sale of capital assets are recorded as revenues Interest Revenue Certificates of deposit 6,000 Revenue ,000 To record interest earned and reinvested in certificates of deposit

Authorization of Grant Receivable from state government 275,000 Revenue ,000 To record municipal education grant authorized by state legislature Receipt of Grant Cash ,000 Receivable from state government 275,000 To record collection of grant from state legislature

Collection of Tax Cash ,281,000 Property tax receivable 1,201,000 Other receivables ,000 To record collection of property tax levied in 2000 and 2001 and other receivables Uncollectible Taxes Estimated uncollectible taxes 19,500 Property tax receivable 19,500 To write off uncollectible 2000 property taxes

Uncollectible Taxes Estimated uncollectible taxes 76,000 Property tax receivable 76,000 To write off uncollectible 2001 property taxes

General Fund - Expenditures
Purchase Order Encumbrances 1,291,000 Reserve for encumbrances ,291,000 To record commitments on goods and services ordered in current year Purchase Order Encumbrances ,000 Reserve for encumbrances ,000 To record a contract to acquire office furnishings and equipment

Receipt of Goods Encumbered Expenditures 1,050,000 Vourchers payable 1,050,000 Reserve for encumbrances ,100,000 Encumbrances ,100,000 To record receipt of goods and services that had been encumbered for $1,100,000

Receipt of Goods Encumbered Expenditures ,000 Vourchers payable ,000 Reserve for encumbrances ,000 Encumbrances ,000 To record receipt of office equipment and furnishings encumbered. Note: this purchase of capital assets is recorded in the same manner as the precious purchase goods and services

Receipt of Goods Unencumbered Expenditures ,000 Vourchers payable ,000 To record receipt of goods and services that had not been encumbered Receipt of Goods/Services Expenditure ,000 Vouchers payable ,000 To record receipt of goods and services ordered in last year

Payment Vouchers payable 1,650,000 Cash ,650,000 To record payment of liabilities Interfund Services Expenditures ,000 Cash (to internal service fund) 200,000 To record services provided by the internal service fund

General Fund - Interfund Transfers
Receipt of Transfer Cash ,000 Due from enterprise fund ,000 To record cash transferred from the enterprise fund Payment of Transfer Due to debt service fund 96,000 Cash ,000 To record authorized transfers of cash to other Model city fund entities

General Fund - Closing Entries
Revenue Unreserved fund balance ,000 Revenue 1,828,000 Estimated revenue 1,860,000 To close out actual and budgeted revenue accounts Expenditure Appropriations 1,944,000 Expenditures (for 2001) 1,710,000 Encumbrances ,000 Unreserved fund balance ,000 To close out appropriations and current year’s expenditures and encumbrances

General Fund - Closing Entries
Prior Year Encumbrances Reserve for encumbrances ,000 Expenditures ,000 Unreserved fund balance ,000 To close out expenditures for goods and services ordered and encumbered in prior year Expenditure Transfers from other funds 150,000 Unreserved fund balance 54,000 Transfers to other funds 96,000 To close out interfund transfers to the unreserved fund balance

Inventory Methods Purchases Method Consumption Method
records purchases as expenditures no inventory is recorded Consumption Method an inventory account carries the beginning balance during the year at year end, the inventory and expenditure accounts are adjusted to reflect the ending balance

Chapter 19: Introduction to Accounting for State and Local Governmental Units

Components in Governmental Accounting
Governmental funds (expendable) Proprietary funds (nonexpendable) Fiduciary funds Account groups

Governmental Funds Accounting focus:
sources, use and balances of current financial resources compliance with legal provisions that specify the types of revenues to be raised and purposes for which financial resources may be expended

Types of Governmental Funds
General fund account for all financial resources unaccounted for in another fund Special revenue funds to account for proceeds of specific revenue sources Capital projects funds to account for resources to be used for acquisition/construction of major capital facilities

Types of Governmental Funds
Debt service funds to account for accumulation of resources for, and payment of, general long term debt principal and interest Permanent funds to account for resources legally restricted such that only earnings may be used for government programs

Proprietary Funds Accounting focus:
determination of operating income, changes in net assets, financial position, and cash flows

Types of Proprietary Funds
Enterprise funds to account for any activity for which a fee is charged to external users Internal service funds to account for any activity that provides goods or services to other government agencies on a cost-reimbursement basis

Fiduciary Funds Accounting focus:
reports assets held in a trustee or agency capacity and that cannot be used to support the government’s own programs focus on net assets and change in net assets

Types of Fiduciary Funds
Pension funds Investment trust funds Private-purpose funds Agency funds

Account Groups General fixed assets account group
to account for all fixed assets of a governmental unit other than those related to specific proprietary funds or trust funds General long-term obligation account group to account for all unmatured general obligation liabilities of a governmental unit other than those of proprietary funds or trust funds

Capital Project Funds - Early Stage
Setting Up The Fund Due from state government 1,000,000 Grant Revenue ,000,000 To record authorization of library construction grant by state legislature Bond Issuance Cash ,100,000 Bond issue proceeds - other financing sources 2,100,000 To record receipt of proceeds from issuance of bond securities

Premium on Bond Issuance Transfer to debt service fund 100,000 Cash ,000 To transfer bond premium to debt service fund Investment Certificates of deposit 1,000,000 Cash ,000,000 To record investment of excess cash in temporary investments

Construction Contract Encumbrances 2,500,000 Reserve for encumbrances ,500 ,000 To record signing of construction contract Receipt of Grant Cash ,000 Due from state government 750,000 To record collection of grant from state legislature

Fees Unencumbered Expenditures ,000 Vourchers payable ,000 To record unencumbered expenditures for architect and legal fees Billings on Construction Expenditures 1,300,000 Contracts payable 1,300,000 Reserve for encumbrances 1,300,000 Encumbrances ,300,000 To record billings on construction completed to date and to remove the encumbrance

Payment Vouchers payable ,000 Contracts payable 1,300,000 Cash ,450,000 To record payment of liabilities Interest Revenue Interest receivable 12,500 Interest Revenue ,500 To record interest earned on certificates of deposit

Capital Project Funds - Year End
Revenues Closing Entry Bond issue proceeds 2,100,000 Grant revenue 1,000,000 Interest revenue ,500 Transfer to debt service fund ,000 Unreserved fund balance 3,012,500 To record revenue and related accounts to unreserved fund balance

Capital Project Funds - Year End
Expenditures Closing Entry Unreserved fund balance 2,700,000 Encumbrances ,200,000 Expenditures ,500,000 To record expenditures and encumbrances accounts to unreserved fund balance

Capital Project Funds Completion of Construction
Reestablish Encumbrances Encumbrances 1,200,000 Unreserved fund balance 1,200,000 To reestablish contract encumbrance closed out at end of previous year Expenditures Unencumbered Expenditures ,000 Vourchers payable ,000 To record unencumbered expenditures

Receipt of Grant Cash ,000 Due from state government ,000 To record collection of grant from state legislature Redemption of CD Cash ,020,000 Certificate of deposit 1,000,00 Interest receivable ,500 Interest Revenue ,500 To record redemption of certificates of deposit

Final Contract Billing Expenditures 1,200,000 Contracts payable 1,200,000 Reserve for encumbrances 1,200,000 Encumbrances ,200,000 To record billing on construction completed and to remove remaining encumbrance

Payment Contracts payable 1,200,000 Contracts payable - retained percentage ,000 Cash ,075,000 To record payment of contract except for 5% retention Payment Vouchers payable ,000 Cash ,000 To record payment of liabilities

Final Payment Contracts payable - retained percentage 125,000 Cash ,000 To record final payment on contract Fund Balance Transfer to debt service fund - other financing use 63,333 Expenditures ,667 Cash ,000 To transfer fund balance to debt service fund

Debt Service Funds - Term Bonds
Transfer from capital projects fund Cash ,000 Transfer from capital projects fund - other financing use ,000 Investment in CD Certificates of deposit 100,000 Cash ,000 Interest receivable from CD Interest receivable 4,000 Interest income 4,000

Budget Additions Required additions ,595 Required earnings ,760 Fund balance ,355 Budgeted Bond Interest for Current Year Fund balance ,000 Appropriations ,000 Property taxes earmarked Property tax receivable 503,000 Allowance for uncollectible taxes ,000 Revenue ,000

Property taxes collected Cash ,000 Property tax receivable ,000 Investment of fund resources Investments ,000 Premium on investments ,000 Cash ,000 Received interest on investments Cash ,000 Interest receivable ,000 Interest income ,000

Property taxes collected Allowance for uncollectible taxes 13,000 Property tax receivable 13,000 Accrued interest on investments Interest receivable ,000 Interest income ,000 Premium amortization Interest income ,200 Premium on investments 1,200

Accrued interest on bonds Expenditures ,000 Interest payable ,000 Payment of interest on bonds Interest payable ,000 Cash ,000

Year End Closing entries Revenue ,000 Required additions ,595 Fund balance Interest income 41,800 Required earnings ,760 Fund balance ,040 Appropriations ,000 Expenditures ,000

Closing out the fund Expenditures - principal 2,000,000 Expenditures - interest ,000 Cash ,160,000 Transfer to X fund - other financing use 60,000 Cash ,000 Fund balance 2,220,000 Expenditures - principal 2,000,000 Expenditures - interest ,000 Transfers to X funds -other financing use ,000

Endowment Funds Classics endowment fund Classic acquisition fund
to account for the nonexpendable fund principal and the investment a permanent fund Classic acquisition fund to account for the expenditure of the earnings of the endowment fund a special revenue fund

General Fixed Assets Account Group
Purchase of a fixed asset Machinery and equipment 250,000 Investment from general fund revenues 250,000 Sale of a fixed asset Investment from general fund reserves 225,000 Accumulated depreciation 140,000 Machinery and equipment ,000 Reduction in investment from general fund revenues ,000

Construction of a fixed asset Construction in progress 1,500,000 Investment from general obligation bonds 1,000,000 Investment from state grant ,000 Construction completed Land ,000 Buildings 2,725,000 Investment from general obligation bonds ,000 Investment from state grant ,000 Construction in progress 1,500,000

Depreciation Reduction in investment in general fixed assets due to accumulation depreciation ,000 Accumulation depreciation - building 120,000 Accumulation depreciation - machinery 55,000 Accumulation depreciation - improvements 131,000

General Long-term Obligation Account Group
Bond issuance Resources to be provided in future years for payment of term bonds 2,000,000 Term bonds payable 2,000,000 Increase in debt service fund Resources available in debt service fund - term bonds ,000 Resources to be provided in future years for payment of term bonds ,000

Government-wide Statements
Help users assess government’s investment in capital assets assess services received during the year identify cost shifts to other periods highlights net cost of each government function/program

Types of Interfund Activities
reciprocal activities similar to exchange transactions interfund loans: receivables and payables interfund services: revenues and expenses nonreciprocal activities interfund transfers: other financing sources, other financing uses interfund reimbursements

Chapter 20: Accounting for Nongovernment Nonbusiness Organizations: Colleges and Universities, Hospitals, and Other Health Care Organizations

Sources of Accounting Standard
First level of priority FASB Statement and Interpretations APB Opinions AICPA Accounting Research Bulletins Second level of priority FASB Technical Bulletins AICPA Industry Audit and Accounting Guides

Sources of Accounting Standard
Third level of priority Consensus positions of the FASB emerging issues task force AICPA AcSec Practice Bulletins Fourth level of priority AICPA Accounting Interpretations Implementation guides Industry practices

Basic Financial Statements
Statement of financial position Asset categories: Unrestricted net assets Temporarily restricted net assets (donor imposed restriction) Permanently restricted net assets (endowments) Statement of activities Statement of cash flows

Basic Funds Current fund Plant fund Endowment fund Loan fund
unrestricted fund (general fund - hospitals) restricted fund (special purpose fund - hospitals) Plant fund Endowment fund Loan fund Agency or custodial fund Annuity and life income fund

Restricted VS Unrestricted Funds
Current unrestricted funds financial resources that may be expended at the discretion of the governing board Current restricted funds resources restricted because of legal, contractual, or external restrictions on their use

Board Designated Funds
Part of current unrestricted fund resources designated by governing board for specific purposes, projects, or investment to limit discretion of management governing board can modify designations at will = assets whose use is limited in hospitals

Mandatory VS Nonmandatory Transfers
Unique to colleges and universities Mandatory transfers transfers from the current funds group to other fund groups arising from binding legal agreements grant agreements Nonmandatory transfers transfers from the current funds group to other fund groups at the discretion of the governing board

Contributions Pledges Estimated Uncollectible Pledges
Pledges receivable ,000 Revenue - contributions ,000 To record gross amount of campaign pledges Estimated Uncollectible Pledges Expenses - Provision for uncollectible pledges ,000 Allowance for uncollectible pledges 45,000 To record provision for estimated uncollectible pledges

Contributions Donated Services
Management and general expense 21,000 Donated services revenue 21,000 Donated services are recognized only if the services received: (1) require specialized skills (2) are provided by individuals possessing those skills and (3) would need to be purchased if not provided by donation

Plant Funds - Colleges 4 Self-balancing subgroups:
unexpended plant fund resources used to purchase property, plant and equipment similar to capital project fund in governmental accounting funds for renewals and replacements

Plant Funds - Colleges funds for retirement of indebtedness
resources to be used to retire or pay interest on debt incurred in acquisition of property similar to debt service fund in governmental accounting Investment in plants property, plant and equipment, related debt, and net investment in plan similar to a combination of the account groups in governmental accounting

Plant Funds - Colleges Current Unrestricted Fund Unexpended Plant Fund
Nonmandatory Transfer to plant fund 50,000 Cash ,000 To record transfer to plant fund Unexpended Plant Fund Cash ,000 Notes payable ,000 Revenue - contributions - restricted 200,000 Fund balance - unrestricted ,000 To record receipt of resources

Plant Funds - Colleges Unexpended Plant Fund
Land ,000 Cash ,000 To record acquisition of land Fund balance - restricted 200,000 Fund balance - unrestricted ,000 Notes payable ,000 Land ,000 To transfer assets and liabilities to investment in plant fund

Plant Funds - Colleges Investment in Plant Fund
Land ,000 Notes payable ,000 Net investment in plant ,000 To record acquisition of land and related indebtedness from the unexpended plant fund Funds for Retirement of Indebtedness Fund balance - restricted 200,000 Cash ,000 Interest expense ,000 Cash ,000 To record payment of principal and interest on indebtedness

Plant Funds - Colleges Investment in Plant Fund
Notes payable ,000 Net investment in plant ,000 To record reduction in indebtedness Depreciation expense 235,000 Accumulated depreciation ,000 To record depreciation on property, plant and equipment included in the assets of the investment in plant fund

Plant Funds - Hospitals
PPE transactions of hospitals are recorded in the general fund contributed resources restricted for acquisition of PPE are recorded in a plant replacement and expansion (restricted) fund upon expenditure, the assets acquired and the plant fund balance are transferred to the general fund

Endowment Funds Endowment Fund Current Unrestricted Fund
Cash ,000 Due to unrestricted fund ,000 Due to restricted fund ,000 To record receipt of dividend and interest Current Unrestricted Fund Due from endowment fund 250,000 Unrestricted income ,000 To record unrestricted endowment fund income

Endowment Funds Current Restricted Fund
Due from endowment fund 150,000 Restricted income ,000 To record restricted endowment fund income Research expense ,000 Cash ,000 To record payment of research grant

Cash ,000 Revenue - contributions - unrestricted 800,000 To record unrestricted contribution Equity investments ,000 Cash ,000 To record purchase of marketable securities

Cash ,000 Investment income - unrestricted 30,000 To record receipt of dividend Equity investments 20,000 Unrealized gain on investment - unrestricted 20,000 (1) investment in equity securities with readily determinable fair values and all debt securities should be recorded at market value (2) unrealized gains and losses are recognized

Loan Funds To account for
loans to students and staff of colleges, loans to employees of hospitals loans to beneficiaries of the interests of certain ONNOs revenues and expenses must be recognized on an accrual basis generally revolving

Annuity and Life Income Funds
Annuity funds the organization receives contribution of assets and makes periodic payments of a stated amount to a beneficiary Life income funds the amount of payment varies depending on the earnings of the fund

Annuity Funds To record establishment of fund
Investments ,000 Annuity payable ,400 Revenue - contributions- permanent restriction 56,600 To record establishment of fund Cash ,000 Annuity payable ,000 To record investment income Annuity payable 26,000 Cash ,000 To record annual annuity payment

Issues Relating to Hospitals
Charity care Contractual allowances Capitation revenues malpractice

Advanced Accounting Debra Jeter Paul Chaney.

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