2. Advanced Accounting, Third Edition4
Consolidated Financial Statements After Acquisition
Advanced Accounting, Third Edition

3. Learning Objectives
Describe the accounting treatment required under current GAAP for varying levels of influence or control by investors.
Prepare journal entries on the parent’s books to account for an investment using the cost method, the partial equity method, and the complete equity method.
Understand the use of the workpaper in preparing consolidated financial statements.
Prepare a schedule for the computation and allocation of the difference between implied and book values.
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)

4. Learning Objectives
Prepare the workpaper eliminating entries for the year of acquisition (and subsequent years) for the cost and equity methods.
Describe two alternative methods to account for interim acquisitions of subsidiary stock at the end of the first year.
Explain how the consolidated statement of cash flows differs from a single firm’s statement of cash flows.
Understand how the reporting of an acquisition on the consolidated statement of cash flows differs when stock is issued rather than cash.
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)

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

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

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

8. Accounting for Investments by the Cost Method
E4-1 Percy Company purchased 80% of the outstanding voting shares of Song Company at the beginning of 2006 for $387,000. At the time of purchase, Song Company’s total stockholders’ equity amounted to $475,000. Income and dividend distributions for Song Company from 2006 through 2008 are as follows:
Required: Prepare journal entries for Percy Company from the date of purchase through 2008 to account for its investment in Song Company under each of the following assumptions:
LO 2 Journal entries for Parent using cost method.

9. Accounting for Investments by the Cost Method
E4-1 A. Percy Company uses the cost method to record its investment.
2006
Investment in Song 387,000
Cash 387,000
Cash 20,000
Dividend income (.8 x $25,000) 20,000
LO 2 Journal entries for Parent using cost method.

10. Accounting for Investments by the Cost Method
E4-1 A. Percy Company uses the cost method to record its investment.
2007
Cash 40,000
Dividend income (.8 x $50,000) 40,000
2008
Cash 28,000
Investment in Song (.8 x $35,000) 28,000
(Liquidating dividend)
LO 2 Journal entries for Parent using cost method.

11. Accounting for Investments by Partial Equity
E4-1 B. Percy Company uses the partial equity method to record its investment.
2006
Investment in Song 387,000
Cash 387,000
Investment in Song 50,800
Equity income (.8 x $63,500) 50,800
Cash 20,000
Investment in Song (.8 x $25,000) 20,000
LO 2 Journal entries for Parent using partial equity method.

12. Accounting for Investments by Partial Equity
E4-1 B. Percy Company uses the partial equity method to record its investment.
2007
Investment in Song 42,000
Equity income (.8 x $52,500) 42,000
Cash 40,000
Investment in Song (.8 x $50,000) 40,000
LO 2 Journal entries for Parent using partial equity method.

13. Accounting for Investments by Partial Equity
E4-1 B. Percy Company uses the partial equity method to record its investment.
2008
Equity loss (.8 x $55,000) 44,000
Investment in Song 44,000
Cash 28,000
Investment in Song (.8 x $35,000) 28,000
LO 2 Journal entries for Parent using partial equity method.

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

15. Accounting for Investments by Complete Equity
E4-1 C. Percy Company uses the complete equity method to record its investment.
2006
Investment in Song 387,000
Cash 387,000
Investment in Song 50,800
Equity income (.8 x $63,500) 50,800
Cash 20,000
Investment in Song (.8 x $25,000) 20,000
LO 2 Journal entries for Parent using complete equity method.

16. Accounting for Investments by Complete Equity
E4-1 C. Percy Company uses the complete equity method to record its investment.
A journal entry is required to adjust for depreciation related to the excess of market over book values of depreciable assets.
Cost of investment $387,000
Book value acquired ($475,000 x 80%) 380,000
Difference between Cost and Book value $ 7,000
2006
Equity income ($7,000 / 10 yrs.) 700
Investment in Song 700
LO 2 Journal entries for Parent using complete equity method.

17. Accounting for Investments by Complete Equity
E4-1 C. Percy Company uses the complete equity method to record its investment.
2007
Investment in Song 42,000
Equity income (.8 x $52,500) 42,000
Cash 40,000
Investment in Song (.8 x $50,000) 40,000
Equity income ($7,000 / 10 yrs.) 700
Investment in Song 700
LO 2 Journal entries for Parent using complete equity method.

18. Accounting for Investments by Complete Equity
E4-1 C. Percy Company uses the complete equity method to record its investment.
2008
Equity Loss (.8 x $55,000) 44,000
Investment in Song 44,000
Cash 28,000
Investment in Song (.8 x $35,000) 28,000
Equity income ($7,000 / 10) 700
Investment in Song 700
LO 2 Journal entries for Parent using complete equity method.

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

20. Consolidated Statements After Acquisition
Year of Acquisition—Cost Method
P4-8 On January 1, 2007, Parker Company purchased 95% of the outstanding common stock of Sid Company for $160,000. At that time, Sid’s stockholders’ equity consisted of common stock, $120,000; other contributed capital, $10,000; and retained earnings, $23,000.
Required:
A. Prepare a consolidated statements workpaper on Dec. 31, 2007.
B. Prepare a consolidated statements workpaper on Dec. 31, 2008.
LO 3 Use of workpapers.

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

22. Consolidated Statements After Acquisition
P4-8 A Year of Acquisition
On December 31, 2007, the two companies’ trial balances were as follows at right:
Required A. Prepare a consolidated statements workpaper on December 31, 2007.
LO 5 Workpapers eliminating entries.

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

24. Consolidated Statements After Acquisition
P4-8 A Year of Acquisition
LO 5 Workpapers eliminating entries.

25. Consolidated Statements After Acquisition
Workpaper Observations
Each section of the workpaper represents one of three consolidated financial statements.
Elimination of the investment account.
Common stock 120,000
Other contributed capital 10,000
Retained earnings, 1/1 23,000
Difference between Implied and Book 15,421
Noncontrolling interest in equity 8,421
Investment in Sid 160,000
LO 5 Workpapers eliminating entries.

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

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

28. Consolidated Statements After Acquisition
Workpaper Observations
Consolidated retained earnings:
Parker Company’s retained earnings, 1/1 $ 40,000
+ Parker’s income 129,000
Dividends from Sid Company - 19,000
+ Parker’s percentage of Sid income (95%) 24,700
Parker’s dividends declared - 20,000
Parker Company’s retained earnings, 12/31 $154,700
LO 5 Workpapers eliminating entries.

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

30. Consolidated Statements After Acquisition
After Year of Acquisition – Cost Method
P4-8 B. 2008
On December 31, 2008, the two companies’ trial balances were as follows at right:
Required B. Prepare a consolidated statements workpaper on December 31, 2008.
LO 5 Workpapers eliminating entries after acquisition (cost method).

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

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

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

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

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

36. Recording Investments – Equity Method
Example (Equity Method) On January 1, 2007, Pennington Corporation purchased 30% of the common shares of Edwards Company for $180,000. During the year, Edwards earned net income of $80,000 and paid dividends of $20,000.
Instructions
Prepare the journal entries for Pennington to record the purchase and any additional entries related to this investment in Edwards Company in 2007.
LO 5 Workpaper eliminating entries (equity method).

37. Recording Investments – Equity Method
Example Prepare the entries for Pennington to record the purchase and any additional entries related to this investment in Edwards Company in 2007.
Investment in Stock 180,000
Cash 180,000
Investment in Stock 24,000
Equity in subsidiary income ($80,000 x 30%) 24,000
Cash 6,000
Investment in Stock ($20,000 x 30%) 6,000
LO 5 Workpaper eliminating entries (equity method).

38. Recording Investments – Equity Method
Investment Carried at Equity—Year of Acquisition
P4-12 On January 1, 2007, Parker Company purchased 90% of the outstanding common stock of Sid Company for $180,000. At that time, Sid’s stockholders’ equity consisted of common stock, $120,000; other contributed capital, $20,000; and retained earnings, $25,000. Assume that any difference between book value of equity and the value implied by the purchase price is attributable to land.
Required:
A. Prepare a consolidated statements workpaper on Dec. 31, 2007.
B. Prepare a consolidated statements workpaper on Dec. 31, 2008.
LO 5 Workpaper eliminating entries (equity method).

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

40. Recording Investments – Equity Method
P4-12 A Year of Acquisition
On December 31, 2007, the two companies’ trial balances were as follows:
Required A. Prepare a consolidated statements workpaper on December 31, 2007.
LO 5 Workpaper eliminating entries (equity method).

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

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

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

44. Recording Investments – Equity Method
Investment Carried at Equity—After Year of Acquisition
P4-12 B. 2008
On December 31, 2008, the two companies’ trial balances were as follows at right:
Required B. Prepare a consolidated statements workpaper on December 31, 2008.
LO 5 Workpaper eliminating entries (equity method).

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

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

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

48. Interim Acquisitions of Subsidiary Stock
Equity Method—Full-Year Reporting Alternative
P4-16
Pillow Company purchased 90% of the common stock of Satin Company on May 1, 2006, for a cash payment of $474,000. December 31, 2006, trial balances for Pillow and Satin were:
LO 6 Two approaches for interim acquisitions.

49. Interim Acquisitions of Subsidiary Stock
P4-16
Satin Company declared a $60,000 cash dividend on December 20, 2006, payable on January 10, 2007, to stockholders of record on December 31, Pillow Company recognized the dividend on its declaration date. Any difference between book value and the value implied by the purchase price relates to subsidiary land, included in property and equipment.
Required: Prepare a consolidated statements workpaper at December 31, 2006, assuming that Satin Company uses the full- year reporting alternative.
LO 6 Two approaches for interim acquisitions.

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

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

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

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

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

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

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

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